If you’re new to real estate investing, understanding rental yield is key. What is it and what makes it one of the most important elements for rental property investment success? It’s basically an important measurement for the kind of return on investment (ROI) you can expect on a rental property. A good rental yield could be a sign of a good return, but of course, there are more details involved. We’ll cover everything below.
Related: How to Buy Your First Rental Property in 8 Steps
What Is Rental Yield?
However, finding and maintaining a profitable income property won’t be easy if you don’t know how to actually evaluate its profitability. Rental property with a good rental yield is a good place to start.
Related: What Is a Good Return on Real Estate Investment?
Putting it simply, rental yield is the cash generated by your income generating asset annually as a percentage of its value. So like we said, it’s a measure of the return on rental property investment. It’s especially important for beginner investors to know what is a good rental yield because it lets them know if they’re making money with a rental property- if they’re profiting.
How Do You Calculate Yield on a Rental Property?
Before you can analyze what is a good rental yield and what isn’t, you need to know how to make one key distinction. Calculating rental yield is much simpler when you know the two types:
- Gross Rental Yield
- Net Rental Yield
Gross Rental Yield
Gross rental yield for your rental property is its annual rental income divided by your property’s value/price (multiplied by 100 to get the percentage). The property’s price is comprised of the purchase price, all closing costs, and any renovation costs.
If your rental property has a value of $300,000 and rents for $1,000 a month, the gross rental yield is:
Annual Rental Income: ($1,000 x 12)= $12,000
Gross Rental Yield: $12,000/$300,000= 0.04 x 100= 4%
Gross rental yield isn’t the most accurate measurement of an investment’s return because it’s missing a key part of the workings of a rental property- the expenses.
Net Rental Yield
A more valuable number, the net rental yield, also known as the capitalization rate (cap rate), includes the operating expenses for the property. Evaluating what is a good rental yield is more reliable using the “net” calculation because it takes into account key expenses which can cut into profits. These include legal fees, loan fees, building inspections, repairs and maintenance, management fees, vacancy costs, insurance costs, and other rates and charges.
It can be calculated by subtracting annual expenses from the annual rent, then dividing that number by the property’s value and multiplying the final number by 100 for the percentage.
Continuing with the same example, let’s now include your rental property’s total expenses for the year ($3,000). Net rental yield is:
$12,000- $3,000= $9,000/$300,000= 0.03 x 100= 3%
Note: Haven’t determined your property’s value? You can use the median property value of rental comps in your market to help you get an estimate.
What Is a Good Rental Yield?
So what is considered a “good” yield for your rental property? In a perfect world, 7-8 percent would be the ideal rental yield. However, things are a bit more complicated.
A big mistake most first-time investors make is valuating a property based on only one dimension. Many think if the rental property has a high yield, it’s a perfect investment with great returns. Unfortunately, that’s usually not the case. There are many other factors that affect the attractiveness of a rental property.
Now, experienced real estate investors who know how to manage their properties well and are looking to improve cash flow can succeed in chasing this strategy. A property with a high net rental yield is ideal for risk-averse investors who want to afford peace of mind as their investment generates good cash flow and ultimately takes care of the mortgage payments.
However, experts advise against selecting a property solely based on rental yield. Upon further research, you’ll find that what is a good rental yield, isn’t necessarily a high rental yield. This is because high yielding income properties can come with increased risk or little capital growth.
Related: What’s a Good Cap Rate for Investment Properties?
Your First Rental Property
What you want with your first rental property is a good rental yield that can balance out with strong capital growth for a better performing portfolio over the long term. So what is a good rental yield for your first rental property? It depends on your personal preferences and your specific investment property. There’s no universal percentage that is the rental yield. If you’re like the risk-averse investors going after cash flow, you might prefer a higher yield. But if you’re a real estate investor chasing capital growth, implementing the buy and hold strategy, a good rental yield would be acceptable at a somewhat lower value.
Here are a few tips to achieve a good rental yield with your first rental property.
Increasing Cash Flow for a Good Rental Yield
- Choose markets with high rental demand and manage your leases well
- Spend money to make money: Simple renovations like a fresh repaint will allow you to enjoy premium rent
- Rent by the room
- Increase marketing efforts to avoid vacancy
- Utilize all income producing assets in your property (parking lot, laundry room, etc)
Investing Smart
To help you really understand the financial aspect of real estate investing, we recommend using a rental property calculator. Mashvisor‘s includes all the key return on investment calculations (including a cap rate calculator for net rental yield). It also provides valuable insights into analysis so you fully understand your property. Find out what is a good rental yield for your rental property in your neighborhood with our advisory tools. All you need to do is sign up now!
To start your 14-day free trial with Mashvisor and subscribe to our services with a 20% discount after, click here.
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