Rental Yield: Understanding the Potential Earnings of an Investment Property

When considering buying an investment property, one crucial factor to assess is its rental yield. Rental yield is a percentage that represents the expected annual income from the property. This not only helps in determining if a property aligns with your wealth-building goals, but it also provides a benchmark for comparing against other investments that are typically measured in terms of percentage returns on an annual basis.

It’s important to understand the different terminology associated with property investment. Often, real estate agents may talk about a property’s “return,” which refers to its past performance and does not necessarily reflect its future earning potential.

There are four key terms used to outline the earning potential of a property:

1. Real estate yield: This measures the future income of an investment as an annual percentage, based on the cost or market value of the property.

2. Gross rental yield: This represents the gross income from an investment before subtracting expenses. Expenses on a rental property can be significant, resulting in a difference between a property’s gross and net rental yield.

3. Net rental yield: This reflects the income from an investment property after subtracting expenses. Typical expenses include purchasing and transaction costs, as well as repair and maintenance costs.

4. Return: This refers to the total gain or loss on an investment over the holding period, including capital gains. It’s usually expressed in dollars or as a percentage based on the amount of profit made on the investment.

Calculating rental yield involves the following steps:

1. Subtract ongoing expenses and vacancy costs from the property’s annual rental income (weekly rent x 52).

2. Divide the number calculated in step 1 by the property’s value.

3. Multiply the number calculated in step 2 by 100 to get the percentage.

For example, if you purchased a property this year for $400,000, rented it out for $350 per week, and incurred annual expenses of $2,500 (including lost rent, advertising, repairs, and maintenance, and insurance), the formula to calculate the net rental yield would be:

Net rental yield = (Annual rent of $18,200 - Annual expenses of $2,500) / Property value of $400,000 x 100 = 3.93%

The ideal rental yield for your investment property should align with your financial situation and wealth-building goals. If you prioritize cash flow, you may opt for a higher-yielding property with less potential for rapid capital growth. If you are focused on long-term capital growth, you may consider a property with lower rental yield but higher growth potential. It ultimately depends on your goals and risk appetite, and it’s important to review and analyse each scenario with the help of qualified finance and legal professionals before making any significant changes to your investments.

Even if you are not currently in the market for a rental property, it’s worthwhile to calculate the gross and net rental yield on your existing properties to identify opportunities for increasing your yield. As always, seeking tailored advice from qualified professionals is essential before making any major financial or investment decisions.