Every real estate investor has come across the term “rental yield”. For a real estate investor, this is an important concept to understand in order to assess the potential rental income and cash flow from an investment property. When it comes to understanding how rental yield is defined and how to calculate rental yield, there is more than one way to answer these questions. So, without further ado, let’s begin our discussion about the intriguing concept of RENTAL YIELD!
How to calculate rental yield:
There are two types of rental yield: gross and net. It’s important to understand the difference between the two types and how to calculate rental yield of each type. So, before even thinking about how to calculate rental yield, take a look at the following.
Gross rental yield
To work out the gross rental yield, you need two key figures: the annual rental income and the property value.
- Annual rental income = weekly rent x 52
- Property value = could be the purchase price or the market value, depending on whether you are looking at the current performance or future prediction.
Once you’ve worked out the two figures above, understanding how to calculate rental yield becomes quite simple:
Gross rental yield = (Annual rental income / Property value) x 100
Net rental yield
The net rental yield will help you determine whether or not the rental property is a smart real estate investment choice. If calculations show that you are paying too much for the investment property, you can re-evaluate your investment decision.
Here is how to go about the net rental yield calculations and exactly how to calculate rental yield in this case.
- Calculate your annual expenses by adding up a year’s worth of the investment property repair costs, property taxes, landlord insurance, property management, and real estate agent fees.
- To calculate the net rental yield, subtract the annual expenses from the annual rent and divide this result by the total cost of the investment property. The result should be multiplied by 100 for the net rental yield percentage.
- Knowing the net rental yield helps a real estate investor plan ahead because it provides an insight on how much money to set aside for the rental property’s upkeep and other expenses.
Related: How to Calculate Rental Yield
There is an important concept to keep in mind when leaning how to calculate rental yield. Whilst the gross rental yield is a simple calculation to use, it’s important to note that it doesn’t take expenses into account. A rental property may have a high rental yield but may also have high expenses making the return on investment low when taken into consideration.
If you do want a more precise calculation, you will need to know or estimate the total expenses of the rental property, including both the purchasing and the transaction costs (the property purchase price, stamp duty, legal fees, pest and building inspections, any start up loan fees, etc.) and the annual costs such as vacancy costs (lost rent and advertising), repairs and maintenance, professional property management fees, home and contents insurance, etc. So, let’s quickly talk about the costs to consider and factor into your plans when learning how to calculate rental yield for your investment property.
Costs to consider and factor into your plans are:
1. Insurance premiums
The premium amount will vary depending on the size of the investment property, the rental property type, and the property location. Typically, however, it’ll probably take up between 2% and 3% of the rent, although this may also be higher if the investment property is furnished.
2. Replacing broken fixtures and fittings
At the end of each tenancy, it’s likely that there will be worn out fixtures and fittings. You’ll also need to factor in the need to re-paint every few years.
You’ll need to factor in maintenance costs. The type, age, and condition of the investment property will all affect the level of maintenance required, so keep this in mind when selecting your rental property. Yes, we know what you’re thinking: There is a lot to learn before mastering the concept of rental yield. Who said learning how to calculate rental yield was easy?
4. Ground rent
If the property is leasehold, then you’ll also have to factor in ground rent and service charges.
5. Empty periods
There’s a good chance that your rental property won’t always be occupied. Periods without tenants means there’s no rent coming in. Factor in this possibility, and even account for as much as a month’s rent just in case. If you buy well and set the rent appropriately, hopefully this won’t be a problem for long.
6. Agent fees
If you use a letting agent or a managing agent, you’ll have to pay a fee. This could include marketing, advertising, professional property management, referencing, and inventories. It depends how much you’re asking the agent to do, but it can range from just 4% to almost 20% in some areas of the country.
Of course, the largest sum will probably be your mortgage. Competitive deals are now available, but you’ll need to put up around 10% of the property’s value as a minimum, although even these are rare. The deposit amount comes as a direct cost to you too, so remember that.
Finally, also remember that some of these can be claimed back against your tax bill, but it’s still wise to take them into account. Likewise, although you can offset mortgage interest against tax on rental income, anything above that will be taxed at income tax rates.
However, all of this is worthwhile. Once you’ve deducted all of these costs, you’ll have found your ‘net yield’, with the costs deducted from your rental income. So, if you divide this into the value of the investment property, including all the costs associated with buying the rental property, you’ll have the net rental yield.
Calculating a yield can be a complex process, and it’s different for each of your investment properties. Remember to check and reassess this amount regularly as it’s likely to change if you alter the level of rent or pay some money off your mortgage. At the end of the day, knowing and understanding how to calculate rental yield for your investment property can help you succeed in the real estate investing business.
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