For anyone interested in buying an investment property, one of the key considerations you and your accountant will undoubtedly review before making a purchase decision is the potential rental return your property will generate, or in other words its yield.
Here is a look at what yields are, how to calculate them and what is considered a good one.
In simple terms rental yield is the profit generated by your investment as a percentage of its value. Investors use their rental yield to evaluate the income they generatre from their investment and to compare properties. A high rental yield equates to greater cash flow.
There are two types of rental yields investors need to be aware of:
Gross rental yield is your annual rental income received from a property before tax divided by the property’s value. The higher the yield the better.
Net rental yield is the income on an investment after expenses have been deducted. Expenses include purchasing and transaction costs such as; stamp duty, legal fees, pest and building inspections, loan start up fees, advertising and rent lost through vacancy.
There may also be repairs and maintenance costs, insurance fees, property management fees, advertising costs etc that can also be predicted to determine the estimated net rental yield.
A yield is calculated as a percentage for both gross and net yield over the previous 12 months. Gross yield is calculated before any expenses are taken into account. Net yield includes expenses such as property vacancy, insurance, running and management fees, maintenance and stamp duty costs.
Annual rental income divided by property value times 100. This gives you the percentage of your gross rental yield.
Annual rental income minus annual expenses and costs divide by property value times 100. This will be the percentage of your net rental yield.
Make sure when you’re looking for an invest property that you understand the difference between gross and net yield to help accurately determine your expected yearly return.
If you don’t have the actual price of the asset when assessing its viability, calculate the median price of similar properties in the areas you want to invest. This will give you a good working estimate of the yield of the potential investment.
There really isn’t an ideal yield to strive for, but according to the Commonwealth Bank of Australia, they if you are looking to rental yield potential as a deciding factor when purchasing a property, they suggest aim for 5.5 per cent or higher because of the stability in its strong rental income.
However a property with strong rental yield may not offer a strong capital return over the long run – that is influenced by a number of factors.
For example a large 2 bedroom apartment in Sydney’s inner west might have the same rent as a 2 bedroom house in the same suburb and have cost less to buy. The apartment would have a higher rental yield and therefore be better for short term cash flow. However the value of the house may increase more over the longer term and offer a higher capital gain. Of course capital gain is not guaranteed.
Many investors have been caught out by high yielding properties. They have bought a property based on the yield alone only to find that the property market in the area they selected didn’t move for years, with no capital growth achieved. Without capital growth their ability to grow their portfolio came to a crashing halt.
So, while rental yield is a helpful measure it shouldn’t be the only consideration you use when trying to determine which investment property to buy. You’ll need to think about your goals and financial circumstances and of course talk to your accountant and financial planner.
A key priority for all investors is undoubtedly to grow the value of their portfolio while providing the best possible returns along the way. The good news is, one of the benefits of investing in property is you have the ability to make changes, that if done correctly and without over capitalisation, can help you appeal to good quality tenants, and also add long term value to your asset.
To find out how you can add value and renter appeal to your investment property and potentially achieve a higher yield, read our 12 Ways to Add Value to your Investment Property here.
Yields are only an estimate of expected profit on your property, as outside influences can intervene. You could be faced with your property being vacant for a long period of time, large and on going maintenance costs and rates. These factors decrease the net yield on your property.
While buying an investment property isn’t an exact science, The Australian Securities and Investments Commission (ASIC) advises the following on its website when looking for an investment property:
Every investor has different goals, some look for cash flow, others capital gains, some want to land bank, buy a place in a holiday destination so they can also enjoy it, or they want a mix of all of these. Yield is only one measure of investment potential, make sure you sure work with your financial advisor and accountant to assess any investment property against your complete goals and objectives.