A real estate market analysis and an investment property analysis would be obsolete without the mention of rental yield. If you’re a beginning real estate investor, you’ve probably heard about this term, but may confuse it with other real estate metrics, such as cash on cash return and return on investment. This blog’s goal is to untangle that confusion. Here’s all you need to know about rental yield, everything from how to calculate rental yield to why it’s important!
Rental Yield: The Basics
Rental yield is a form of rate of return that helps real estate investors measure the profitability of rental properties. The two main factors that rental yield considers are the annual rental income and the property purchase price (or the fair market value). From this definition, it is clear that the higher the rental yield, the more profitable the rental property.
The Two Types of Rental Yield
Rental yield comes in two types: gross rental yield and net rental yield. Gross and net rental yield are somewhat similar, but have significant differences.
How to Calculate Rental Yield: Gross Rental Yield
From its name, you can tell that gross rental yield is rental yield that does not consider expenses, such as taxes. Since we’re discussing rental properties, this rental yield is before tax and rental expenses are deducted. As a result, when you calculate gross rental yield, you essentially calculate rental yield before tax, and rental expenses are subtracted by the annual rental income. Here’s what that looks like:
Gross Rental Yield = Annual Rental Income/Property Price (or FMV)
How to Calculate Rental Yield: Net Rental Yield
Gross rental yield’s usefulness is limited, since it factors in income before tax and doesn’t factor in rental expenses. However, the second type of rental yield, net rental yield, solves these problems. Net rental yield adjusts the before tax annual rental income of gross rental yield to rental income deducted after tax and rental expenses.
Net Rental Yield = (Annual Rental Income – Total Rental Expenses)/Property Price (or FMV) × 100%
The above formula is a bit clunky. It can be cleaned up by noting that the difference between after tax rental income and expenses equals the net operating income of a property:
Net Rental Yield = Net Operating Income (NOI)/Property Price (or FMV) × 100%
What Rental Yield Tells Real Estate Investors
When it comes to searching for profitable real estate investments, knowing how to calculate rental yield is vital. The main usage of rental yield (especially gross rental yield) is to project the potential profitability of rental properties. Then, real estate investors can use this data to compare investment properties of interest. By estimating the annual rental income of an investment property, deducting rental expenses, and dividing it by the property’s price (all of which can be done with Mashvisor’s investment property analysis), real estate investors can determine a property’s potential for profit as a ratio of its value or price.
What Rental Yield Doesn’t Tell Real Estate Investors
There’s no denying that knowing rental yield is among the most valuable real estate metrics out there. It does, however, have some limitations. For one, it is mostly useful when comparing potential profitable real estate investments for purchase. If you are an investor interested in selling or are actively renting out investment properties, rental yield would not carry much weight for you.
Another limitation with rental yield is that it may not give real estate investors the full picture about an investment property. There are much more data and real estate metrics investors must consider before making a property purchase. An investment property analysis and a real estate market analysis would not be complete without rental yield, but much more information is needed. Data relating to the neighborhood itself, the property type, and the rental strategy (again, all of which can be found with Mashvisor’s real estate market analysis) should be obtained by real estate investors before any purchase.
Is There a Difference Between Rental Yield and Return on Investment?
By the sound of it, rental yield seems very similar, identical even, to return on investment (ROI). After all, there formulas are virtually the same:
Net Rental Yield = (Annual Rental Income – Total Rental Expenses)/Property Price × 100 %
Return on Investment = (Annual Rental Income – Total Costs and Expenses)/Property Price × 100 %
Although the way to calculate rental yield is very similar to the way to compute ROI, there exists a huge difference between the two. Rental yield projects an estimation of potential profitability, while return on investment measures the actual profitability of a property. In other words, you calculate rental yield when you’re interested in determining how profitable real estate investments could potentially be. Return on investment, on the other hand, is calculated when determining how profitable a rental property actually is. Rental yield is primarily used to compare properties for purchase. ROI is mainly focused on measuring an active property’s income profit.
Is There a Difference Between Rental Yield and Cap Rate?
Despite what was just mentioned, rental yield can function as an ROI metric. The only time this happens is when using net rental yield, which is more commonly known as cap rate.
Net Rental Yield = (NOI/Property Price) × 100% = Capitalization Rate
Net rental yield factors in expenses and costs associated with actively renting out properties. It can, therefore, be considered an ROI metric. The same cannot be said about gross rental yield.
Mashvisor: The Best Tool to Calculate Rental Yield and Other Real Estate Metrics
Now that you know all there is to know about how to calculate rental yield, it’s time to put what you’ve learned into practice! You can use Mashvisor to obtain the data necessary to calculate rental yield. Better yet, you can let Mashvisor calculate rental yield for you! Whatever the case, be sure to use Mashvisor to muster all the real estate metrics you need to have profitable real estate investments!