Knowing how to calculate the yield being generated by a property is a great basic skill that all budding property tycoons should have in their toolbox.
What is a Yield?
The first thing you probably need to ask yourself is what is a property yield? The rental yield is simply the annual income generated by the property expressed as a percentage of the value of the property. The rental yield is typically used to benchmark property investments and compare alternative investments.
There are two types of yields that most investors typically use:
- Gross Yield
- Net Yield
Gross Yield
The gross yield is the easiest return to calculate, but also the least accurate. It is simply the annual rent (before any deductions) divided by the purchase price of the property. For example, if you were to purchase a property for $500,000 and it rented out for $500 per week. The Gross Yield would be calculated as follows:
Purchase Price = $500,000
Annual Rent = $26,000 ($500 per week)
GROSS YIELD = 5.2% (26,000/500,000)
When do you use Gross Yield?
The gross yield is not a particularly accurate way of either determining whether a property is ‘good’ or for comparing different property investments. Therefore there are limited circumstances in which you should use gross yield.
When to use Gross Yield:
- Initial Review – undertaking a detailed analysis of a potential investment can require a significant amount of time and effort. The gross yield can be a useful tool to determine whether or not an investment is worth further investigation.
- Low Operating Costs – if you know that a property has relatively low operating costs the gross yield can be a useful comparison tool.
- Compare Similar Properties – gross yield can also be a useful tool when comparing two similar properties.
Net Yield
The net yield is a more accurate reflection of the income generated by a property. This is because it takes into account the costs associated with operating the investment. The net yield is the return the property generates after the expenses associated with operating it are subtracted. These include transaction costs, management fees, repairs and maintenance costs, property taxes, and insurance.
Therefore, using our earlier example if the property has the following operating costs property management (8% of the gross rental), maintenance costs (2% of the gross rental), insurance ($1,000 p.a.), and property taxes ($1,000 p.a.). The Net Yield would be calculated as follows:
Purchase Price = $500,000
Annual Rent = $26,000 ($500 per week)
less Operating Costs:
Property Management = $2,080 ($26,000 x 8%)
Maintenace Costs = $520 ($26,000 x 2%)
Insurance = $1,000
Property Taxes = $1,000
Net Income = $23,200
NET YIELD = 4.64% (23,200/500,000)
When do you Use Net Yield?
The net yield is a more accurate way of comparing different property investments. This is because the net yield takes into account the operating costs associated with a specific property. The costs associated with operating different property investments can vary significantly which makes the net yield a much more useful tool to compare different investment properties.
Is Yield that Important?
The yield a property generates provides a good snapshot of what the likely performance of the property will be. However, it should not be treated as the be-all and end-all for making property investment decisions.
Using property Yield has several limitations, including:
- Capital Appreciation – the yield is simply a snapshot of a property’s return at a specific point in time. It does not specifically take into account the future growth potential of a property’s capital value. Most investors buy real estate with the intention of achieving price growth, therefore, the yield is not necessarily the best measure of performance.
- Taxes – the yield does not take into real estate taxes which can vary significantly between countries and indeed who purchases the property, as well as why they have purchased the property.
Important notice: Proptech Pioneer and its associated companies seek to provide investors with guides, information and tools, but we cannot guarantee this information to be accurate or perfect. You use the information at your own risk and accept no liability if you rely on this information. Proptech Pioneer is not a tax advisor, accountant conveyancer, lawyer, financial advisor or mortgage advisor. You should seek independent advice from independent professionals before making any investment decision.
