Rental yield: what is it and how is it calculated?

Investing in property can be a great way to create wealth, but it's vital to understand the key metrics that drive success in this field. One such metric is rental yield.?

What is rental yield?

Rental yield is the return on a property investment, represented as a percentage. It shows how much a property earns in rent compared to its purchase price or current market value.

Why is rental yield important?

Rental yield is a key indicator of a property’s performance.?

It helps investors understand their cash flow, compare properties, and make strategic decisions about pricing rentals, property upgrades, or future investments. High rental yields usually suggest a property is generating significant income relative to its cost, while low yields can indicate either a high purchase price or low rental income.

Gross vs net rental yield

There are two types of rental yields: gross and net.?

Gross rental yield simply considers the annual rental income against the property's purchase price.?

Net rental yield, on the other hand, takes into account additional costs associated with owning and maintaining the property, providing a more accurate picture of the return on investment.

Calculating gross rental yield

Gross rental yield is calculated by dividing the annual rental income by the property’s purchase price, then multiplying the result by 100 to get a percentage.?

For instance, if a property is purchased for $500,000 and rented out for $25,000 per year, the gross rental yield would be (25,000 / 500,000) x 100 = 5%.

Calculating net rental yield

To calculate net rental yield, you need to subtract all the annual expenses from the annual rental income, divide this figure by the property’s purchase price, and then multiply by 100.?

Let’s suppose the property above incurs $5,000 in annual expenses. This would mean the net rental yield would be ((25,000 - 5,000) / 500,000) x 100 = 4%.

Expenses affecting net rental yield

Several expenses can impact the net rental yield, including:

• Council rates
• Insurance
• Strata fees (for apartments)
• Maintenance and repairs
• Property management fees
• Land Tax

Using rental yield in investment decisions

Rental yield can be a valuable tool for property investors.?

It helps in:

• Comparing potential investments: A higher yield might indicate a more profitable property
• Setting rental rates: Understanding market yields can help set competitive and realistic rental prices
• Strategic planning: Rental yield can guide decisions on whether to hold or sell a property

What constitutes a ‘good’ rental yield?

A 'good' rental yield depends on various factors, including location, property type, and specific features.?

For instance, properties in high-demand urban areas might yield lower rental returns but offer better capital growth prospects. Conversely, regional properties might offer higher yields but slower capital appreciation.

Houses v apartments: rental yield comparison

Generally, apartments tend to have higher rental yields compared to houses. This is often due to their lower purchase prices and appeal to renters seeking affordable, well-located properties. However, houses can offer better long-term capital growth, making them appealing for different investment strategies.

Boosting rental yield

Investors can improve their property’s rental yield by:

• Renovating or updating the property to attract higher-paying tenants
• Adding features that are in demand, like air conditioning or a dishwasher
• Reviewing and adjusting rent regularly to align with market rates

High rental yield: one of many investment strategies

While a high rental yield is attractive, it's just one strategy in property investment. For example, some investors might focus on the long-term appreciation of the property’s value. They often choose properties in areas with strong potential for growth, even if the current rental yield is low. The aim here is to make a profit through an increase in the property’s value over time.

Other investors might buy a property whose expenses (like loan interest, maintenance, and other costs) exceed the income it generates. This is known as negative gearing. The immediate financial loss can often be offset against other income for tax purposes. The long-term goal is capital appreciation that outweighs these losses.

Each of these strategies has its risks and benefits, and what works for one investor may not suit another. As such, it can be a good idea to seek professional advice to help determine the best investment approach for your circumstances.?

Looking to buy a high-quality investment property? Auswide Buyer’s Agency can help. To discuss your options, book a free consultation with Ashish Malhotra