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What is a rental yield?
Rental yield is the income generated from your investment property by calculating the difference between the sum of overall costs on a property and the rent received from the property. Understanding and calculating rental yield helps gain a good perspective on knowing the investment potential of the rental property. It also helps the investor to choose the best rental yielding property by comparing the property values with respective rental yield ratios and make a wise decision.
It can also be called as rental income calculator or cash flow calculator. Understanding rental yield concepts are important to create a successful investment strategy. It helps the investor to track on the investments that are over performing or under performing on their Rental Portfolio.
Rental yield can be calculated in two ways,
Gross rental yield
Net rental yield
Both types of yield measure
ROI (Return of investment)
ROR (rate of return)
Gross Rental Yield
Gross rental yield is obtained by calculating the annual rental income against the value of the property. Annual rental income is calculated by multiplying weekly rent by 52 or Monthly rent by 12. The value of the property represents either purchase price of the property or the current market value of the property.
For example, if a rental home with a market value of $200,000 generates a gross annual rent of $16,000 per year, the gross rental yield is 8.0%
($16,000 annual gross rental income / $200,000 property value) *100
(16000/200000) * 100 = 8.0%
The property with high Gross rental yield doesn't mean the property has high rental yield since the operational costs of a property are not taken into account. Property with high Gross yield may not be good if the operational costs are too high.
The gross yield calculation helps filter down potential rental investments before analyzing property in detail. For more detailed analysis, Net rental yield (includes all the operational costs of the rental property) is calculated.
Net Rental Yield
Net rental yield is a much precise way to calculate the rental yield as it includes all the operational costs and acquisition costs involved in purchase of an investment rental property.
Net rental yield is calculated by taking to account of all the costs that are involved in buying rental property. Operational expenses vary widely depending on the location, age of an investment property, Insurance, Infrastructure, Vacancy rates etc.
Annual Expenses
Vacancy Costs
Repairs and Maintenance
Inspection
Managing Fees
Rental Advertising
Insurance
Property Tax
HOA Fees
Total Property Costs
Value of the Property
Agent fees
Legal fees
Other acquisition costs
From the previous example,
Property value = $200000
Annual rental income = $16000
Let's add an annual expense of $3000.
Net rental yield = [(Annual rental income - annual expenses) / total property costs] x 100
= [(16,000 - 4000) / 200000] x 100
= 6%
The rental yield may rise or fall depending on a number of factors and may impact your potential rental yield. So, its always mandatory to keep an eye on the market fluctuations to know the impact on the investment property accordingly.
Proactive maintenance is important so that the minor repairs can be handled at an earlier stage before they get complicated.
The mortgage payments ( Principal and interest ) are not taken into account in the above examples. Most of the rental investments need 25% down payment. Investment properties also have a depreciation factor where you can write off the whole purchase price broken down to certain number of years to waive tax.
Residential Property = 27.5 Years
Commercial Property = 39 Years
On the whole, Gross rental yield is good for filtering down the investment properties and Net rental yield helps in analyzing the properties in detail to identify the properties with most income potential.
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