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Before you purchase a rental property you will want to know if it’s a good investment. You can do this by calculating your rental yield.
To estimate the kind of returns an investment property will give you, you need to know the purchase price and estimated rental return for your property as well as an estimate for your expenses. You can get rental estimates from websites like Zillow Research or RentRange.
Once you’ve purchased a property you will want to keep an eye on your rental yield to ensure that you are charging the right amount and that your property is making the returns you need to turn a profit.
Hopefully, when you calculate a current rentals yield this will match or exceed your previous calculations.
Rental yield is a measure of how much cash an income generating asset produces each year as a percentage of that asset’s value. For real estate, it is the rental income as a percentage of the property’s value.
There are two kinds of yields you’ll hear about: gross yield and net yield.
This is the income return on your investment before any expenses, outgoings or possible rental vacancies are taken into account. Gross yield also does not take interest rates into account.
Gross rental yield is commonly used when looking at returns, as it is simple to calculate and lets you easily compare properties with different values and rental returns.
You take the ‘Annual rental income’ and divide by the ‘Property value’. Then multiply this number by 100 to get a percentage value.
Property value $600,000. Expected rent $3,000 a month.
$3,000 x 12 = $36,000 (annual rental income)
($36,000 /$600,000) x 100 = 6% gross rental yield
This is, in many ways, a much more useful number. This takes into account any expenses or other outgoings, such as maintenance costs, mortgage payments, and insurance. Net yield is sometimes referred to as ‘rate of return’.
Take the ‘Annual rental income’ and subtract the ‘Annual expenses’. Then divide this number by the ‘Property value’ and then multiply by 100 to get a percentage value.
Property value $600,000, expected rent $3,000 a month and expenses/loss $6000.
(($36,000 – $6000)/$600,000) x 100 = 5% Net Rental Yield
A rental asset should have a positive cash flow even after surprise expenses. You will want to calculate how quickly you can make a property positive after your initial expenses immediately after purchasing the property (eg. renovations).
This should be considered on a yearly basis as well as an overall basis to give yourself the best possible understanding of your property’s cash flow.
This calculation is how long will it take for your property to earn back it’s value. We work this out in our calculator from your cash flow, vacancy rate, and property purchase price. However, you should also consider mortgage interest rates when calculating this.
So, the question we’ve all been waiting for. What is a good rental yield? What should you be aiming for?
There is no universal answer to this question, as determining the strength of an investment depends on numerous factors. In an ideal world you’d aim for 7-8% however, it is definitely worth noting though, that this isn’t the one and only answer.
Other factors that should be taken into consideration, include but are not limited to:
Is the property in a desirable location, near amenities, near public transport? etc.
How long do you plan on holding the property?
What capital gains can be expected? Is the purchase price good?
Have you done work on the property?
What is your overall investment strategy and how does this property play into your long term financial goals?
Are there any local developments that might damage the property of the value eg. plans to further develop a nearby airport?
Are there any signs indicating a property bubble in the area? Is the state introducing tighter rental regulations?
A high rental yield is certainly a good thing to have. However, the best investors consider as many facets of their investment as possible to help themselves achieve the best returns from their investment portfolio in the long run.
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