Rental yields are a measure of returns on rental properties. When you purchase a property, the thought process is to rent it out, collect the rent and hopefully receive a profit once the mortgage is paid off. However, since investments can fluctuate in value and sometimes not go your way it can be useful to also understand how they are performing. This allows you to make informed decisions on whether you should keep or sell the rental property, whether you should switch investment strategies or look for additional income streams through other areas of real estate investing.
Rental yields are an important metric for investors – and it’s important to know what you’re paying before you buy. Here, we break down how rental yields work, so you can see whether or not your potential rental investment is worthwhile.
Calculating Rental Yield
Calculating yields is a way to evaluate how much income your investments are generating. There are two types of rental yields – gross and net. Gross rental yield is a quick way to make a rough comparison of how its rental returns fare with others in an area, but it does not give a full picture of the investment potential a property offers. On the other hand, Net rental yield offers a more detailed picture of a property’s rental return. To calculate net rental yield, you also factor in the costs and expenses you incur in addition to your property’s value.
Gross rental yield
Here’s how to calculate gross rental yield:
- Sum up your total annual rent that you would charge a tenant
- Divide your annual rent by the value of the property
- Multiply that figure by 100 to get the percentage of your gross rental yield
For example, if you collect $20,800 rent annually ($400 per week) and your property value is $450,000, it will look like this:
Step 1: $20,800 (annual rent) / $450,000 (property value) = 0.0462
Step 2: 0.0462 x 100 = 4.622
Result: The gross rental yield is therefore expressed as 4.622%
Net rental yield
The credibility of net rental yield is dependent on the accuracy of assumptions you make about the cost of repairs, the property’s market value, and the property’s occupancy rate. To calculate net rental yield accurately will involve the following steps:
- Add up all the fees and expenses of owning the property
- Sum up the annual rent you will receive from the property
- subtract the total expenses from the annual rent
- Divide it by the value of the property
- Multiply by 100
What is a good rental yield?
This depends on where you plan to buy. In metropolitan areas, especially state capitals, gross rental yields typically range from 3-5%. In regional areas, gross rental yield can be 5%-plus.
In addition to calculating rental yield, it’s also important to do your due diligence before making any final decisions. Consider the resale value, investigate market reports, demographics, sales and rental history in an area, planning and infrastructure, and the story of the building. All these factors can have an impact on the future investment of your property.
Rental income is a form of passive income, making it appealing to many investors.
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