A property’s rental yield is one of the most often-used indicators for investors assessing a property’s investment potential. Every property investor’s dream is to find a rental property that promises huge capital gains in a highly sought-after location with a high rental return and low management costs.
It’s common for many real estate listing websites and investment magazines to highlight certain suburbs around Australia for the median rental yield they could potentially achieve. However, the quoted yield you see on a property’s sale listing might not always be the number you think it is.
What is rental yield?
Yield is the measure of how much income an asset produces each year and is shown as a percentage of that asset’s value. For real estate, the rental yield is the rental income the property generates shown as a percentage of the property’s market value.
There are generally two types of rental yield figures to take into account when doing your calculations: gross yield and net yield.
Gross rental yield: Gross rental yield is the measure of the total rental income received expressed as a percentage of the property’s market value.
Net rental yield: Net rental yield is the measure of total rental income received, less any expenses or purchase transaction costs, expressed as a percentage of the property’s purchase price.
Using rental yields to check an investment property’s potential
Many real estate market listings tend to advertise a gross rental yield on the property’s market listing in the hopes of attracting investing buyers to the property. It’s common for some real estate agents to display an attractively high gross rental yield that doesn’t take into account a range of other factors that could indicate the property might not be generating as good a rental return as you initially expected.
It’s also worth noting that some real estate websites and magazines might be displaying yield numbers that are historical. In some cases, they may be compiled from information that is several months out of date. In other cases, they might only be showing the median yield across an entire suburb.
The key to using yields to check a property’s investment potential is to take a few minutes to run some simple calculations on your own before choosing one investment property over another.
Here are some quick calculations you can use:
Calculating gross rental yield: Gross rental yield is the simplest calculation to make, so it’s often the one used in real estate market listings.
Annual rental income / market value x 100 = Gross rental yield
So, if a property is generating $400 per week rent and is advertised for sale at $400,000, the calculation is as follows:
(400 x 52) = $20,800 annual rental income divided by $400,000 x 100 = 5.2%
Calculating net rental yield: A more accurate indicator of a property’s likely rental return is to calculate the net rental yield. The net rental yield takes into account the expenses and costs associated with buying the property to give a more realistic figure. Before you can calculate the net rental yield, you will need to know or estimate what the property’s annual expenses are. The calculation is as follows:
(Annual rental income – annual expenses) / (total property costs) x 100
= net rental yield
Before calculating a property’s net rental yield, you will need some information first. You’ll need to know the property’s annual expenses, such as the property management fees, vacancy costs, council and water rates, insurance premium costs, and body corporate or strata levies (if any).
Notice that the costs associated with mortgage interest charges or taxes aren’t included in expenses. Those expenses are pertinent to the individual owner’s financial situation, not the property, so they’re not included for the purpose of this calculation.
The other aspect of the equation involves sorting out the total property costs, so you’ll need to take into account include the property’s purchase price, plus all the transaction costs associated with buying the property. If you intend to complete repairs or renovations before tenants move in, include the estimated costs of those items in this figure too.
For the purpose of this example, we’ll assume that the property’s annual expenses are $5,000 per annum. We’ll also assume that the stamp duty and other costs associated with the property purchase come to $20,000.
So, if you purchase a property for $400,000, plus $20,000 in associated costs, and your rental income is $400 per week ($20,800 per year), you also have $5,000 in annual expenses to factor in. The calculation is as follows:
(Annual rental income – annual expenses) / (total property costs) x 100
= net rental yield
($20,800 – $5,000) / ($400,000 + $20,000) x 100 = 3.76%
Before you start investigating one suburb over another based on its potential for great rental yields, take a moment to determine what the advertised number really means to your investment strategy. Work out whether the number shown is the gross of net rental yield. Then take the time to do your own calculations to see what returns you’re really getting for your investment.
