HOW TO CALCULATE INVESTMENT PROPERTY YIELD
Investment property yield is something that is often talked about – but what exactly is it? And, how do you figure it out?
Read on to find out what yield is and how to calculate it without fuss.
WHAT IS GROSS YIELD?
A property’s gross yield is essentially its rental income expressed as a percentage of the property’s purchase price or value.
Take this example:
A property purchased for $250,000, with a weekly rent of $300 (or, yearly rent of $15,600) has a gross yield of 6.24%.
To put it another way, the yearly rental income ($15,600) is 6.24% of $250,000.
WHAT IS THE DIFFERENCE BETWEEN GROSS YIELD AND NET YIELD?
Gross rental yield is calculated by using just the rental income and purchase price (or market value) of a property alone. It’s a quick and rough way of evaluating a property against others. It doesn’t factor in holding costs.
However, net yield takes does take other purchase and holding costs into account to calculate a more realistic figure. Net yield is a better at estimating the actual cash flow of a property.
SHOULD YOU CALCULATE YIELD ON PURCHASE PRICE OR MARKET VALUE?
That depends on why you are calculating it.
If you have a below market value purchase lined up, calculating net yield using the purchase price will give you a realistic figure of your cash flow.
You could then calculate gross yield using market value and compare it to other opportunities on the market, to see how it stacks up.
A tendency to use these different measures across these two circumstances is probably the source of some peoples confusion.
BE WARY ABOUT WHAT IS ADVERTISED
Consider this. An advertised property may quote a 6% yield, but leaves out the rental details. You compare it with other properties on the current market that have a much smaller yield, from 4 – 5%.
On the surface, the advertised property looks like a much better deal – but is it?
Using an estimated weekly rental amount you calculate the yield yourself, using the current market value. You find the yield is actually the same as other properties on the market.
So, why the discrepancy? Because, the seller has calculated the yield using the purchase price from when they bought the property five years ago.
Since then, market value has gone up considerably. So too has the purchase price on the property. It is now on the market for $100,000 more than what the seller paid for it.
Shifty? (Well… that’s one way of putting it.)
HOW TO CALCULATE GROSS YIELD
This simple equation will help you figure out the gross yield of an investment property.
Gross rental yield = Annual rental income (weekly rent x 52) / purchase price or market value x 100.
Let’s take the above mentioned example.
6.24% = $15,600 ($300 x 52) / $250,000 x 100
But what good is knowing this if it doesn’t take the property’s cash flow into account? While it can be a useful calculation to help you compare prospective purchases against the market, knowing the net yield will help you figure out how lucrative the property will be after all expenses.
HOW TO CALCULATE NET YIELD
The equation for net yield is essentially the same, but it requires you to take all other costs of the property (both upfront and ongoing) into account.
WHAT COSTS SHOULD YOU INCLUDE?
– Purchase price (or market value)
– Stamp duty
– Building and pest report
– Legal costs
– Cost of getting the loan
– Renovations or repairs done to make it more rentable.
If you add up all of these costs you will come up with the total property cost.
Ongoing annual expenses:
– Interest repayments
– Strata levies (if applicable)
– Council rates
– Water rates
– Land tax (if applicable)
– Property management and rental listing expenses
– Repair and maintenance
– Loss of rent (in the case of vacancy periods)
If you add up all of these costs you will come up with the total annual expense.
NET YIELD EQUATION
Then, it is simply a matter of applying the following sum:
Net rental yield = [(Annual rental income – total annual expense)/ total property cost] x 100
In other words, you subtract the total annual expense from the yearly rent. Then, you divide this net amount by the total cost of the property. Multiplying this figure by 100 will give you the percentage.
Clearly, this will give you a very different figure to that of the gross yield.
DON’T GET CAUGHT UP ON YIELD ALONE
It is important to remember that yield is only one part of finding a good foundation property.
While a property may have an 8% yield, it may also be in a location where capital growth stagnates or even goes backwards over time.
Some properties are advertised as “great investment opportunities” because they are high yielding. Don’t get caught up on the yield alone.
QUESTIONS TO ASK
Ask the following questions to avoid being blindsided:
– Is the yield gross or net?
– If the above answer is “gross”, what would the net yield be?
– Is the property located in a good growth area?
You may find that a property with 8% gross yield comes with so many ongoing costs that the cash flow is barely neutral.
You may also find that the property is located in a dodgy area, where rental demand is driven by just one industry (yep, we’re talking about all those mining towns that went bust).
On the flip side, a property might have a modest 5-6% gross yield, but its holding costs are low and rental demand is strong which makes the net yield very attractive.
MAKE SURE YOUR TEAM HAS YOUR BACK
The best way to avoid making costly mistakes is to have the right success team. They can help you know what type of property to focus on at each stage of your investing – whether it be cash flow or capital gains you are after.