Unlike the family home, property investing is all about generating a return. This often centres on the value of the property growing over time, but if you are renting your property there is another component that plays a role - the rental yield.
For some investors, the rental yield is the most important factor when choosing an investment property. For others, it may serve as a metric to compare the appeal or performance of a property.
As such, knowing about rental yields, and how to calculate a rental yield, is one of the most useful bits of knowledge you can acquire. We’ll take you through everything now.
Understanding Rental Yield
The starting point in this conversation is understanding exactly what is a rental yield?
If you’ve invested in another asset before, you might even be familiar with the concept of a yield.
Nonetheless, in the context of property, a yield, or rental yield, is a measure of the return on your investment by considering how much income you receive from renting the property as a measure of the value of the property, and the costs associated with your property.
You will typically see rental yield expressed as a percentage, which is the return on your investment per annum. A higher yield indicates a greater return, and generally suggests more cash flow as well.
Why is it Useful to Know the Rental Yield of a Property?
Not only is a rental yield helpful to compare properties in different suburbs, and to determine how your property is performing, but it is also valuable for the sake of conducting a rent review. This ensures you are yielding a return that is appropriate in the context of the market, while also allowing you to track your progress in meeting your financial goals.
If you’re wondering what might be a good rental yield, you need to take into consideration the type of property, and the location. Commercial properties tend to yield more than residential properties, while yields in regional areas also generally outperform those in the city.
As a rough guide, yields for properties in metro areas generally sit between 3-5% per annum, whereas yields in regional areas typically start above that range.
How to Calculate the Rental Yield of a Property
Now you know what a rental yield is, and why it’s important, let’s look at how you can calculate the rental yield of a property.
The first thing you should know is that there are two different types of yields you can calculate: the gross rental yield, and the net rental yield.
In the case of gross rental yields, you are working out the income generated by the property against the value of the property, but without including expenses. You work out the total rent your tenant pays per annum, and divide this by the value of the property. To convert this into a percentage, you then multiply the result by 100.
For example, you rent a 2-bed house for $500 per week ($26,000 per annum). The property is valued at $850,000. The gross rental yield is: (($26,000) / ($850,000)) x 100) = 3.1% p.a.
A more reliable measure, that takes into account property-related expenses, is to calculate the net rental yield. Expenses might include council rates, insurance premiums, depreciation, property management fees, repairs and maintenance, plus more, but excluding loan interest.
The net rental yield requires you to work out the total rent your tenant pays per annum, deduct your annual expenses from this total, then divide the figure by the value of the property. Multiply the result by 100 to convert this into a percentage.
Using the earlier example, let’s assume your property expenses are $6,000 per annum. The net rental yield equals: (($26,000-$6,000) / ($850,000)) x 100) = 2.4% p.a.
There you have it! With this newfound information, make sure you crunch the numbers and work out the rental yield of your investment property before you buy it, and regularly once you rent it out.
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