An investor’s guide to calculating rental yield

Many investors consider rental yield as a factor that affects where and how much they would invest in a property. While it isn’t the only consideration when making investment decisions, it is an important one, as it may help you compare properties and find the best deal in the market.

Rental yield is a measure of how much cash an income-generating asset makes annually. It is the rental income as a percentage of the property’s value. There are two types of yields—gross yield and net yield.

Gross yield

Gross rental yield is the most used calculation. The calculation for gross yield is:

Annual rental income (weekly rental income x 52) / property value x 100 = gross rental yield

For example, you charge $300 of rent per week and your property’s value is $400,000. Your gross rental yield will be computed as $300 x 52 / 4000,000 x 100 = 3.9%.

Gross rental yield calculation is relatively easy. However, it may be inaccurate as it doesn’t consider expenses.

Net yield

Net yield is much more important but not as easy to calculate as gross yield, because it considers all expenses you will incur from maintaining and managing your property. To calculate your net rental yield, you must calculate your annual rental income, including expenses. Net rental yield is calculated using this equation:

Annual rental income—annual expenses / total property cost x 100 = net rental yield

Your total property costs may include:

• Legal fees
• Stamp duty
• Loan fees
• Property purchase price
• Building inspections

Annual expenses may include:

• Vacancy costs
• Repairs and maintenance
• Body corporate fess
• Insurance
• Rates and charges

Sample net rental yield computation:

Interest and tax are not typically considered when calculating net yield. This is because these variables are based on the circumstances of the owner and aren’t directly related to the property itself, according to Jeremy Sheppard, head of research at Select Residential Property.

You should include your mortgage interest rate and tax in when calculating your return of investment. You may also consider factoring in deprecation, land tax, stamp duty, mortgage insurance, etc.

Factors affecting rental yield

Rental yield is important to determine how much you are making off of your property investment. It may also help you make better decisions. The following  are some of the factors that may affect rental yield:

• Location. Popular areas such as suburbs near the inner city may attract high rents due to demand. For example, Melbourne’s one-bedroom apartment market has the highest rental yield in Victoria at 6.7%, according to the Real Estate Institute of Victoria’s (REIV) August 2019 report. The location appeals to employees working in the CBD, higher-education students, and their families. You may check out our Top Suburb page to have a closer look at the Aussie suburbs that may be worth the investment.
• Economy. The area’s economy vastly affects property prices, which in turn affect rental yield. New infrastructure linking the area to nearby cities or making transportation also affect property prices. For example, Cairns, Townsville, and the Hunter region have the highest rental yields in Australia, according to CoreLogic. This may be due to regional towns being bolstered by government infrastructure projects, strengthening the economy.
• Employment. People would like to live a bit closer where they work. When an area’s economy is booming, with more business opening, chances are, more jobs are created. With more jobs and more people to accommodate, properties become more in demand to house these people. You may check the Australian Bureau of Statistics for Employment and Unemployment rates.
• Population. Population and the property market go hand in hand—more people means more housing is needed to accommodate the population. The latest figures from the Australian Bureau of Statistics said the country’s population is set to double by 2075. However, the three levels of government collectively only fund 1.2% of new housing stocks, leaving 98.8% to be accommodated by the private sector.
• Vacancy rates. Vacancy rates indicate the percentage of vacant rental properties. An oversupply of rentals may affect the area’s vacancy rates. A normal vacancy rate can range from 5% to 8% on average.

High yield, better cash flow?

A higher rental yield may mean a better cash flow for your investment property. Ideally, investors should aim for a 5.5% or higher rental yield, according to the Commonwealth Bank of Australia.

However, high rental yield shouldn’t be the sole reason you would want to invest in a rental property. Many investors have found that high yielding properties can come at a cost of little capital growth (the property’s increase in value over time), negative cash flow, or increased risk, says property investor Lindy Lear.

Checking the rental yield in your prospective area is one of the steps you may do as part of your research. You may use the rental yield to estimate cash flow and calculate the projected return on investment. However, make sure that the yield is not due to falling property prices, but from rising rents.

It may be better to assess a prospective investment property based on property drivers of capital growth. Factors that may affect capital growth are location, the property market’s condition, population, and the economic outlook of the area.

Focus on the big picture—you want your property investment to make some money. Do not get carried away chasing high rental yields. Consider the total return versus the risks a property may entail.

If you want more information about rental yield and how can it affect your property investment, consult a professional who can give you more details and suggestions about the property market.