How to work out investment property rental yield?
Anyone considering buying an investment property will be interested in what return the property will give them – in other words, its yield. Before we get into the complexities around yields and how to work these out, it’s helpful to understand the different terms.
Before starting to look seriously at a property, most investors work out the yield on the property to see if it makes their shortlist. Although some investors buy property for other reasons – land banking, infrastructure potential or lifestyle reasons – most are only concerned with its current return and potential yield.
Before we get into the complexities around yields and how to work these out, it’s helpful to understand the different terms.
Investment terms explained
Yield – A yield is a measurement of future income on an investment. It is generally calculated annually as a percentage, based on the asset’s (or investment’s) cost or market value. It has nothing to do with a capital gain on a property.
Gross yield – If you think about your ‘gross earnings’, then you are on the right track. A gross yield is the income on an investment prior to expenses being deducted. For property, these expenses can be quite substantial so there can be a huge difference between gross and net yield.
Net yield – As you can expect from above, the net yield is the income on an investment after expenses have been deducted. The costs and expenses could include purchasing and transactions cost. For example, stamp duty, legal fees, pest and building inspections, loan start-up fees and vacancy costs, including lost rent and advertising. There might also be repairs and maintenance costs, management fees, insurance, rates, and charges. Most of the time, these costs won’t be known so you will have to estimate these.
Return or total return – Also quoted as a percentage, a return includes capital gains. It is the gain or loss of the investment in a particular period (this isn’t necessarily annual as for yields). This is retrospective, so it is generally an accurate or concrete percentage.
Average yields – It is always good to know what the average yield is for the area that you are looking to invest in, but every property is different. Don’t take these as gospel as to how much yield you may get on your property. What is the difference between yield and return?
As explained in the definitions above, a yield is only based on income, whereas a return includes capital gains. Although both might be used in the sales pattern, find out the time frames of both before making any decisions on whether the property you are looking at is a good investment.
Remember, though, one is retrospective (return) and the other looks at the future (yield).
A yield is only based on income, whereas a return includes capital gains
How do you work out a yield?
When looking for investment property, you will notice agents dropping in comments on yields. What you have to be aware of is that most of them will be referring to the ‘gross’ yield and not the ‘net’ yield. Make sure you ask which one they are quoting. It is also worth knowing how to work out the gross and net yield of a property so you can calculate them.
Gross yield = annual rental income (weekly rental x 52) ÷ by property value x 100
For example: Property purchase – $450,000 Weekly rent – $375 ($375 x 52) = $19,500 ÷ $450,000 x 100 = 4.3%
Net yield = annual rental income (weekly rental x 52) – annual expenses and costs ÷ property value x 100
For example: Property purchase – $450,000 Weekly rent – $375 Annual expenses – lost rent and advertising $1,075, repairs budget $600, insurance $1200 = $2875 ($375 x 52) = $19,500 – $2875 ÷ $450,000 x 100 = 3.69%
What does a ‘hard’ or ‘soft’ yield mean?
Demand for property drives property prices up and this can affect the yield of your investment property. The more prices go up, the less the percentage between rents (income) to property value. When you hear people referring to yields hardening, this means the yield falls or reduces, whereas when they refer to yields softening, this means they are increasing or rising.
Contact Wilson Realty for free advice before purchasing your next investment property!
Alan Wilson | Property Investment Specialist
Wilson Realty Group
Source - realestate.com.au