Rental yield is one of the many factors property investors must consider when making decisions – it could spell the difference between a good and bad investment.
In a nutshell, yield is a measure of how much cash an income-generating asset makes annually. Putting this in the context of the rental market, rental yield refers to the rental income as a percentage of the property’s value.
What are the types of rental yield?
Savvy property investors need to understand the difference between gross rental yield and net rental yield for them to understand how a certain market is performing.
While one type is the most used and the easiest to determine, it might also not capture the overall performance of a certain property in a specific market.
Here’s a quick summary of the difference between gross and net rental yields:
Type of Yield
Formula
Gross Rental Yield
Annual rental income / property’s value * 100 = GRY%
Net Rental Yield
(Annual rental income—annual expenses) / total property cost x 100 = NRY%
Gross yield
Gross rental yield is the most used calculation if you want to quickly find out how a market is performing.
For example, you charge $300 rent weekly and your property’s value is $400,000. Your gross rental yield will be calculated as $300 x 52 / 4000,000 x 100 = 3.9%.
Gross rental yield calculation is relatively easy. However, it may be inaccurate as it doesn’t consider your expenses.
Net yield
For a clearer figure that encapsulates other factors, net yield is a better measure.
Net yield considers all expenses you will incur from maintaining and managing your property. These costs may include the following:
Legal fees
Stamp duty
Loan fees
Property purchase price
Building inspections
Annual expenses may include:
Vacancy costs
Repairs and maintenance
Body corporate fess
Insurance
Rates and charges
Here is a sample net rental yield calculation:
Annual
Rent @ $400/week
$20,800
Vacancies based on 2%
$416
Insurance
$500
Repairs and maintenance
$900
Management fees @ 9%
$1870
Net income
$17,114
Property value
$400,000
Net yield (Net income / Property value)
4.3%
Typically, interest and tax are not considered when calculating net yield. These variables are based on the circumstances of the owner and aren’t directly related to the property itself.
However, you should include your mortgage interest rate and tax when calculating your return on investment. You may also consider factoring in deprecation, land tax, stamp duty, mortgage insurance, etc.
What are the factors affecting rental yield?
Rental yield is important to determine how much you are making off of your property investment. The following are some of the factors that may affect rental yield:
1. Location
Popular areas such as suburbs near the inner city may attract high rents due to demand. The location appeals to employees working in the CBD, higher-education students, and their families.
You may check out our Top Suburb page to have a closer look at the Australian suburbs that may be worth the investment.
2. Economy
The area’s economy vastly affects property prices, which in turn affect rental yield.
New infrastructure linking the area to nearby cities or making transportation also affects property prices. Some regional towns, for instance, have high rental yields given due to the local government’s infrastructure investment, which, in turn, strengthens the economy.
3. Employment
People would like to live a bit closer to where they work. When an area’s economy is booming, with more business opening, chances are, more jobs are created.
With more jobs and more people to accommodate, properties become more in demand to house these people.
4. Population
Population and the property market go hand in hand—more people means more housing is needed to accommodate the population.
5. Vacancy rates
Vacancy rates indicate the percentage of vacant rental properties. An oversupply of rentals may affect the area’s vacancy rates. A normal vacancy rate can range from 5% to 8% on average.
Does high yield mean better cash flow?
A higher rental yield may mean a better cash flow for your investment property. Ideally, investors should aim for a 5.5% or higher rental yield.
However, a high rental yield shouldn’t be the sole reason you would want to invest in a rental property. Many investors have found that high-yielding properties can come at a cost of little capital growth, negative cash flow, or increased risk.
Checking the rental yield in your prospective area is one of the steps you may do as part of your research. You may use the rental yield to estimate cash flow and calculate the projected return on investment. However, make sure that the yield is not due to falling property prices, but from rising rents.
It may be better to assess a prospective investment property based on property drivers of capital growth. Factors that may affect capital growth are location, the property market’s condition, population, and the economic outlook of the area.
Focus on the big picture – you want your property investment to make some money. Do not get carried away chasing high rental yields. Consider the total return versus the risks a property may entail.
If you want more information about rental yield and how can it affect your property investment, consult a professional who can give you more details and suggestions about the property market.
