What Is Rental Yield?
Rental yield measures ongoing return on investment for a property. The equation takes the income you generate from a property as a percentage of the property’s value.
Astute investors use rental yield to compare properties. A high rental yield results in better cash flow, which helps to improve the return on investment.
How to calculate gross rental yield
There are 2 types of rental yield you will often hear about. Gross rental yield and net rental yield.
Gross rental yield is the most common calculation used. To work out gross rental yield you need to calculate annual rental income. Do this by taking weekly rental income and multiply by 52. Then divide annual rental income by the property’s value, which can be either the purchase price or market value then multiply by 100.
Use this simple equation:
Gross rental yield = Annual rental income (weekly rental income x 52) / property value x 100
Gross rental is quick and easy but can be inaccurate because it doesn’t factor in expenses. To get a more realistic rental yield you need to use net rental yield, which does factor in expenses.
Net rental yield is a more accurate assessment of a property’s potential.
To work out net rental yield you need to calculate annual rental income including expenses. Do this by taking weekly rental income and multiply by 52 then subtracting annual expenses. Then divide annual rental income by the property’s total cost. Property cost includes the purchase price or market value and things like stamp duty, legal fees, etc. Finally, multiply by 100.
Use this simple calculation:
Net rental yield = (Annual rental income – Annual expenses) / (Total property costs) x 100
Total property costs can include:
property purchase price
pest and building inspections
Annual expenses can include:
repairs and maintenance
managing real estate agent fees
home and contents insurance
rates and charges
Lets see this in action:
Let’s say, you want to buy a property with a purchase price of $500,000. And there are two properties you’re interested in.
The first can generate a weekly rent of $400. Here’s the gross rental yield calculation:
Gross rental yield = (400 x 52) / 500,000 x 100 = 4.16%
The second property on the same street can generate a weekly rent of $550. Here’s the gross rental yield calculation:
Gross rental yield = (550 x 52) / 500,000 x 100 = 5.72%
In this case, the second property has a much more attractive rental yield.
Now let’s look at net rental yield.
Now lets say one of the online home loan calculators estimate that $500,000 with a 20% deposit may have the following expenses:
Expense Cost Stamp duty $17,990
Mortgage fee $136
Transfer fee $136
Based on these expenses the first property’s net rental yield would be:
Net rental yield = (400 x 52 – 4000) / (500,000 + 19,262) x 100 = 3.23%
The first property’s net rental yield works out to 3.23% based on $4,000 in annual expenses.
The second property has much higher annual expenses than property one.
Net rental yield = (550 x 52 – 10000) / (500,000 + 19,262) x 100 = 3.58%
The second property net rental yield works out to 3.58%. The second property’s yield is still higher than the first but it’s much closer than when using gross rental yield.
Rental yield is a useful tool in the property investment decision-making process. But, it should not be the only factor you base any decision on.
A high rental yield will be good for your cash flow, but it doesn’t necessarily indicate the property will offer you a strong capital return in the long run – that’s determined by a whole host of factors.
For example, a large two-bedroom unit in inner Melbourne might command the same rent as a two-bedroom house in the same suburb but cost several thousand dollars less to buy. The former would have a higher rental yield and therefore be better for your short-term cash flow, but the value of the latter could increase by much more over the long term and offer a higher capital gain.
So, rental yield is a helpful measure but it shouldn’t be the only measure you use when trying to pick out an investment property.
Ultimately, you’ll need to think about your goals and your financial circumstances when trying to choose the best property to invest in.