Rental yields - what are they?

29th June 2016

If you've been looking into property investment, then you have likely heard the term 'rental yields' thrown casually into conversations. If this concept is unfamiliar to you, and you are anything like myself, then it has probably left you feeling complexed, confused, and hungry for more information before you dive head first into this (admittedly awesome) investment strategy.

Indeed, rental yields certainly need to be considered before purchasing your new property; it is an investor's dream to obtain a high yielding property, in an area that experiences plenty of capital growth, and generates good return, at little expense. Sounds simple, right? If only!

Here we go, in laymen's terms: rental yields explained.

(Disclaimer: 'rental yields' can be a very dry concept. I would recommend you pour a cup of coffee ☕️, maybe grab a bite to eat 🍎, and play some dulcet forest sounds 🍃 to clear your mind, before attempting to interpret the following information.)

🤔 What exactly does the term 'rental yields' mean?

Essentially, a yield is an estimation of the earning potential of an investment. It is calculated based on the market value of an asset (property), and is expressed as a percentage.

Gross annual yield can be best explained through the following equation:

(Annual rent/Property value) x 100 = Gross Annual Yield

For example, if you receive $400 a week in rent, then your annual rent would be $400 x 52 weeks = $20,800. Divide by a property value of $400,000, and then multiply by 100 to get a percentage, your Gross Annual Yield would look like this:

($20,800/$400,000) x 100 = 5.2%

Thus, your Gross Annual Yield is 5.2%.

Gross yields are regularly used as a reference by real estate agents and other industry professionals, as they are simple to calculate, and allow you to easily compare properties against each other.

⚠️ Is this the only type of yield?

No its not, and you definitely shouldn't make a decision on an investment property based solely on its gross rental yield.

While a property may have a high gross annual income, it may also generate a lot of expenses - so your net profit is significantly reduced. Thus, your net annual yield is a better indicator of an investment's true potential.

(Annual rent - annual rental expenses)/Property value x 100 = Net Rental Yield

The above equation is more reliable when determining the benefits of a property in regards to its yield, as it takes both profits and losses into consideration. Your rental expenses may include things like pest inspections, renovations, insurance, advertising, and loss of rent. If it takes a long time to find tenants, and you don't have rental income to service your investment loan, then this will be eating away at your net rental yield.

👍 What is considered a 'good' yield?

5% is widely considered a benchmark rental yield. This is because 5% roughly equates to $1 back in weekly rent for every $1000 spent on a property.

However, this should not be taken as gospel. Rental yields only make up one piece of the puzzle - you also need to consider capital growth. Sometimes, it can be very difficult to find a property that delivers high rental yields as well as capital gains, so you need to weigh up which element is the most important to you. Are you looking for short term supplementary income? Or would you like an investment that slowly grows in value over time? If you answered yes to the former, then generating a positively geared investment through high rental yields should be your number one priority.

🔓 How can rental yields change?

Housing demand and rental demand can have a significant impact on rental yields. In an area where everyone is looking to purchase property, house prices would likely increase, and as a result, yields would go down. When this happens, you may here people say that "yields have hardened".

The reverse also applies; when an area has a large supply of tenants looking for rentals, then rental prices may go up. If the property value has remained stagnant, then yields are likely to increase. This is an example of "yields softening".

Wow, after all that, I think I need to sit down and relax with a very strong drink in hand (coffee, of course). Hopefully this article has helped to ease the confusion surrounding rental yields. However, if you are still finding it all a little bit overwhelming, your local broker will happily break it down further for you.

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