What is rental yield and how do you calculate it?

What is rental yield and how do you calculate it?
Rental yields are an important factor in the profitability of an investment property. So, what is rental yield and how is it calculated. 
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Rental yield for investment properties explained

If you're a property investor, you're going to want to make a return on your investment property. That's where understanding rental income and yields can be helpful. But what is it? And, how is it calculated?

What is rental yield?

Rental yield is the profit margin you make each year from your investment property. It measures the gap between your costs, like repairs, maintenance, and depreciation, and the income you receive over the year from your tenants.

It allows you to review how your current investment property is performing and whether buying an investment property in a certain suburb is going to be a good investment.

If your current property has had a poor return in the last few years, it may be time to try and sell and find a better-performing area. If you're looking in a new area and find the average rental yield figures are quite high, you may decide it's a good suburb to invest in.

Managing Director of loans.com.au Marie Mortimer emphasises the importance of research your next property before committing to the purchase. 

"If you've decided to sell your current property, or if it's not giving you the returns you'd hoped for, it's crucial to do plenty of research when purchasing your next property to ensure it is a solid investment. You can use things like property reports and recent sale prices in similar areas as a good start," Ms. Mortimer said. 

Whether you have an investment property already or are looking to buy one, understanding potential income returns is a crucial part of assessing whether you're investment is going to be financially successful.

How to calculate rental yield?

There are two types of rental yield: gross and net. You can find out how to calculate each below:

Gross rental yield

Gross rental yield measures your annual rental income with the property value as a percentage.

To calculate:

  1. Add up your rental income for the year to get your total annual rent.
  2. Divide your annual rent by the value of your property.
  3. Multiply that figure by 100 to show your gross yield as a percentage.

Here's the calculation in action. Let's say you made $30,000 in rental income and your property is worth $600,000. Using the calculation that's $30,000 divided by $600,000 multiplied by 100 equals a 5% gross rental yield.

Net rental yield

Net rental yield is similar but takes into account all the expenses you incurred in the year. It's considered a more accurate representation of your investment return.

To calculate:

  1. Add all of the expenses you incurred from owning the property.
  2. Add up your rental income for the year to get your total annual rent.
  3. Subtract the annual expenses from the annual rent.
  4. Divide your annual rent by the value of your property.
  5. Multiply that figure by 100 to show your net yield as a percentage.

Rental expenses you may have incurred include depreciation, insurance, repairs and maintenance, body corporate fees, property manager fees, and council rates.

Let's say you made $30,000 in rental income and your property is worth $600,000. But you also had to fork out $2,000 for repairs, $3,000 for insurance, and $1,000 in body corporate fees, so your expenses total $6,000.

So $30,000 (income) minus $6,000 (expenses) divided by $600,000 (property value) multiplied by 100 equals a 4% rental yield.

What is a good rental yield for an investment property?

There's no blanket rule on what is a good rental yield as expected returns differ on where your investment property is located. Obviously, you always want to have a positive return on your investment otherwise you'd be losing money.

Typically, if you buy in a metropolitan area like a capital city, yields above 3% are considered a good return. If your property is in a regional area, a rental yield above 5% is a well-performing investment.

When assessing investment property yields, it's important to keep in mind both past performance as well as the characteristics of the local property market like current rental demand, vacancy rates, and house prices too. 

How does the property type affect rental yield?

The property type, such as a house vs an apartment, has a serious bearing on your rental yield potential.

For example, houses typically require greater maintenance than an apartment which means your annual costs will be greater. However, they typically have stronger capital growth opportunities and can be easier to renovate, which can increase the value of your home.

On the other hand, apartments are typically a high-yield property type. Apartments often have less upkeep but have expenses like body corporate fees and property management costs.

Given you're buying in a block with a large amount of the same rooms, it can be harder to find capital growth opportunities, which means you may need to spend less on expenses to achieve a higher yield.

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Tags: buying an investment property | investment property

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