One of the most important steps of buying an income property is to analyze its investment potential. There are many metrics used to break down a rental property. Some include cash on cash return, return on investment, cap rate, cash flow, and the topic of this blog – rental yield. Rental yield is important for real estate investors to know and to compute. But before we discuss how to work out rental yield, let’s elaborate more on the concept.
What Is Rental Yield?
Rental yield is a type of rate of return. In this rate of return, the annual income of a rental property is divided by the value of the property. Rental yield is usually expressed as a percentage. The annual income of a property can be computed by multiplying the estimated weekly rent by 52 or by multiplying the estimated monthly rent by 12. The value of the property can refer to its fair market value or its listing price. Another way to look at rental yield is that it’s how much you will earn as rental income in relation to the property’s value, among other things.
How Does Rental Yield Help Real Estate Investors?
To understand rental yield, let’s use an example. Say you are interested in three investment properties. Property A has an estimated annual rent of $18,000, and its purchasing price is $300,000. Property B’s price is $825,000, with an estimated annual rent of $49,500. The third property, Property C, is worth $575,000 and has an estimated annual income of $40,250.
If we were to ask which property is the cheapest to purchase, Property A would be the answer. If we were to purchase an investment property based on the highest rental income, Property B would be the property to buy. However, which property offers the best ROI (return on investment) when considering the property’s rental income and price? That’s what rental yield is able to find out.
How to Work Out Rental Yield?
Now, let’s learn how to work out rental yield.
There are actually two types of rental yield. Each one is calculated differently, and each one is used differently.
The first, and less important, type of rental yield is gross rental yield. Gross rental yield only considers the annual rent of a property and its value. This is how it is calculated:
Gross Rental Yield = (Annual Rental Income / Property’s Value) × 100%
Why is gross rental yield not very significant? It fails to take into account a vital aspect of real estate – expenses and costs. Luckily, its counterpart, net rental yield, takes care of that problem.
Net Rental Yield = [(Annual Rental Income – Expenses and Costs) / Property’s Value] × 100%
Sometimes, when an investment property is being advertised or recommended, its gross rental yield is being presented. Then, when the real estate investor purchases the property and computes its net rental yield, he/she realizes this was not the deal he/she originally settled in for. Therefore, when you’re concerned about how to work out rental yield, think about net rental yield, not gross yield.
Back to the Example
Property A: ($18,000 / $300,000) × 100% = 6%
Property B: ($49,500 / $825,000) × 100% = 6%
Property C: ($40,250 / $575,000) × 100% = 7%
As you can see, Property C has the highest rental yield out of the three properties, making it the best investment among them. Property B may have the highest rent, but its high property value reduces its rental yield. Property A’s gross rental yield is also reduced, not because of its property price (which is relatively cheap), but because of its low rental income.
But again, these rental yields are only the gross ones and are not too helpful in real world applications. Net rental yields are what we’re looking for.
Here’s the same example, but with different amounts of expenses and costs:
Property A: [($18,000 – $5,300) / $300,000] × 100% = 4.23%
Property B: [($49,500 – $8,000) / $825,000] × 100% = 5%
Property C: [($40,250 – $12,000) / $575,000] × 100% = 4.9%
When expenses are accounted for, the entire game changes. For starters, the yields of all three properties have significantly decreased. Also, Property B now becomes the best investment property. Its expenses and costs were not too high relative to its rental income, which resulted in the least decrease.
What Is a Good Rental Yield?
Now that you know the answer to how to work out rental yield, another question arises: What is a good rental yield? The answer will vary depending on whom you ask. Generally, however, rental properties with a yield of 6.5% or more are considered good by most real estate investors. But even then, rental yield is not as important as you may think it is.
Is Rental Yield Important?
Don’t get it twisted, rental yield and knowing how to work out rental yield is important. It’s just not too important when analyzing a rental property. This is mainly due to its variables. Sometimes, an investment property will just be very inexpensive, giving it a high rental yield. However, its reality may be that is does not attract tenants and has negative cash flow.
Rental yields can still be useful, but relying on other metrics will give you the full picture. Other metrics, cash flow in particular, are the best indicators of the potential success of an investment property.
What Can Mashvisor Do for Rental Yield?
It may not be the most significant aspect of an investment property, but you still should know how to work out rental yield. As always, Mashvisor is here to help!
With Mashvisor’s investment property calculator, you can calculate expenses, which is vital for net rental yield. Predictive data will guide you through it all, along with your own inputted figures. Mashvisor helps you answer the question ‘how to work out rental yield’ in more ways, too. A property’s listing price will be displayed, and its annual rent is estimated.
For more answers to intriguing real estate questions, like how to work out rental yield, head over to Mashvisor!