If you're in property investment or looking to enter the market, you've probably heard of the term 'rental yield'. In short, rental yield allows investors to calculate profit margins and compare different property prospects with greater ease.
The measurement is a critical pillar that should guide your investment, as it ultimately determines your return on a property. In this blog post, we break down all things related to rental yield so you can have the best possible property investment strategy.
What Does Rental Yield Mean?
Rental yield is a term that helps determine the return rate for your investment property as a percentage value. When it comes to rental yield, a higher percentage means that you are making more money annually from your investment property.
There are two types of rental yield:
- Gross rental yield: compares only your rental income against your property’s value.
- Net rental yield: factors in your rental income with other related costs (such as insurance or maintenance and upkeep) against your property value.
Why is it Important?
Rental yield is essential in forming the foundation for your property investment strategy. Analysing the current yield with past results is a great way to track the performance of your investment, ultimately providing a sound indication of its growth year to year.
Furthermore, looking at past rental yields of a property can provide you with critical insight into the home before buying. This can include any expenses associated with the property, historical shifts in the market and how much revenue growth has occurred.
While there are no guarantees with investments, doing the math by regularly calculating the rental yield can provide you with a great determination of the value of your investment.
Capital Growth vs Rental Yield
Capital growth is another relevant metric for your investment strategy. This measurement calculates the increase of value in your investment by comparing the current market price to the original purchase price. Ultimately high capital growth demonstrates that your property is in high demand, therefore driving up the return value on your initial investment.
People argue whether pursuing an investment strategy that focuses on capital growth rather than rental yield is more valuable in the long run. However, it depends on your own wants and needs as an investor.
For example, suppose you're a first-time property investor looking to enter the market with lower up-front costs. In that case, rental yield may be a better metric to follow. However, capital growth may be a more sound choice for longer-term investors wanting a stable property that can withstand shifts in the housing market.
At the end of the day, your strategy will need to match your investment expectations.
How to Calculate Rental Yield
Calculating your rental yield is a relatively straightforward process. All you need is an idea of the overall costs associated with your property, alongside the total rental income you're currently earning. The exact equation used differs depending on if you want to know your gross rental yield or your net rental yield.
Gross Rental Yield
To calculate gross rental yield, determine your total annual earnings from rent and divide that number by your property value. Then, simply multiply this result by 100 to calculate your gross rental yield as a percentage.
This quick percentage is important for understanding the fundamental relationship between your income and the property. It isn’t a substitute for the exact yield, but it helps determine if your annual margins are where they should be.
Net Rental Yield
For your net rental yield calculation, you should first find the total sum of all the costs associated with your property investment.
Such costs can include:
- Stamp duty
- Legal costs
- Building and pest inspections
- On-going costs (repair, council rates, loan interest repayments)
To calculate your net yield, take your annual rental income and subtract this from your total expenses. Then, divide this number by your property value and multiply it by 100 to see your net rental yield as a percentage.
Your net rental yield is the most accurate data you can have for keeping an eye on your property compared to the surrounding market factors.
Return of Total Rental Yield
You can calculate the total rental yield when you want to find your return over an exact period. This equation includes capital gains and can change significantly based on annual costs, like notable repairs. Ultimately, total rental yield helps determine past performance over a particular time frame.
What is a Good Rental Yield?
When deciding if your rental yield is either good or bad, you should consider a range of factors such as region, the type of property or vacancy rates.
For example, you can expect slightly lower rental yields in congested urban areas when compared to regionally-located properties. However, property investors generally aim for a net rental yield of around 5%. Furthermore, if your property is guaranteed to the government, like the NDIS, you can also expect a stronger rental yield.
A rental yield between 8% to 10% indicates an excellent return on your investment property. Meanwhile, lower yields tend to be around 2% to 4% and could suggest that your investment property is overvalued.
If your rental yield is lower than you expect, there’s no need to stress, there are plenty of ways to improve the value of your investment.
Can I Improve My Rental Yield?
You can improve your rental yield by employing various strategies to help add value to your property, this includes:
- Investing in updates or makeovers to make your home more modern (particularly in the bathroom and kitchen).
- Providing options for a car space, whether it be on-street parking or building a garage.
- Creating space for more bedrooms (the more tenants, the more rent).
- Installing light fixtures to keep your property looking lively.
- Continually raise the rent along with market standards.
- Installing solar panels to save on expensive power bills.
- Providing storage spaces for tenants.
Types of High Rental Yield Property
The type of property you are investing in is another factor influencing your rental yield. Whether you are investing in commercial or residential real estate, it's essential to understand the key differences in rental yield to guide your investment strategy.
Commercial Property Rental Yield
You can expect much higher rental yields when it comes to commercial properties. The annual yield for commercial property tends to be between 5% and 12%. While commercial properties can incur more immediate expenses, they are more likely to offer a return on investment.
Residential Property Rental Yield
Rental yields from residential property tend to be lower than commercial real estate. This is because commercial real estate requires a significant initial investment and, therefore, can attract higher rates of return.
If you're investing in residential property, you can expect a rental yield of anywhere between 3% to 5%.
To help you understand how rental yield is used to guide your investment strategy, let’s take a look at Henry.
Henry could buy one of two properties for $650,000. The first property generates revenue from a weekly rent of $500, while the second has a weekly rent of $600.
- Gross rental yield for property #1 = (500 x 52) / 650,000 x 100 = 4.00%
- Gross rental yield for property #2 = (600 x 52) / 650,000 x 100 = 4.80%
While this is a pretty clear indicator of which property generates higher rental yield, Henry should also look at what happens when he factors in the different expenses for each property. The first property has annual expenses equal to $5,000, and the second property has annual expenses equal to $12,000.
- Net rental yield for property #1 = (500 x 52 - 5,000) / 650,000 x 100 = 3.23%
- Net rental yield for property #2 = (600 x 52 - 12,000) / 650,000 x 100 = 2.95%
The second property appeared to have a higher return on investment, but the expected expenses mean its net rental yield is lower for Henry.
Other Factors to Consider Aside from Rental Yields
Rental yields are just one pillar of your investment strategy. While it's easy to get obsessed with tracking performance through percentage values, you shouldn't neglect other critical factors. Such factors can include the area's location, population, and economy while also regularly assessing the volatility of the property market.
What is a Reasonable Rental Yield?
The expectations for rental yields are all set by your market. Doing in-depth research on your area can help you find a specific answer. A gross rental yield of around 4% is reasonable for densely populated metropolitan areas. For more rural areas, go for at least 5%.
Is a Higher or Lower Rental Yield Better?
If you are investing with capital growth in mind for long-term gains on selling the property, a lower rental yield would be better. In most circumstances where you want immediate return on investment from your property, you’ll be shooting for a higher rental yield.