What is a ‘rental yield’?
The word ‘yield’, when you’re talking finance, normally refers to the returns you get from an investment (in much the same way a farm ‘yields’ crops).
If you’re buying an investment property, then the ‘rental yield’ is the amount you’re likely to get back from your investment. This is normally calculated over the space of a year, as a percentage of the value of your property.
When you’re calculating rental yields, the value of your property is normally taken either as the purchase price, or the current market value.
Gross rental yield vs. net rental yield
If you’re talking rental yields, you need to identify whether you’re referring to ‘gross’ rental yield or ‘net’ rental yield. The difference between the two is that net rental yield takes your expenses, tax liabilities and benefits, depreciation and various other factors into account – giving you a more precise picture of how much you’re making from your investment property when you take into account all of these other factors.
Gross rental yields are calculated by dividing the gross annual rental income by the purchase price (or the current valuation) – and then multiplying by 100 to give the figure as a percentage:
Gross rental yield (%) = Annual rent income / Property value *100
For example: if a property is leased for $425 per week and the purchase price or market valuation is $500,000, then the gross rental yield is calculated as follows:
($425 x 52) / $500,000 = 4.42%.
Net rental yields are similar, but with your expenses and other factors calculated into the equation. Below is a simplified version of an equation you might use to calculate net rental yield:
Net rental yield (%) = (Annual rent income – expenses, etc.) / Property value * 100
To calculate your overall annual investment return, your rental yield is added to the capital growth return on your investment property (i.e. how much the property’s gone up in value), and expressed as a percentage.
Purchase price versus current valuation
Your rental yield can be calculated as a percentage of either the purchase price, or current market valuation of a property, depending on what you’re trying to do.
Yield is normally calculated with the current gross rent and the original purchase price of your property. Yields are generally only calculated using the property’s current valuation when either:
- You're trying to sell the property, and demonstrating potential rental yields to prospective buyers, or
- You want to refinance the property, in which case a calculation based on the current value will reflect your increased equity.
What causes yields to increase and decrease?
Among other things, decreasing yields can be the result of an oversupply of rental properties in your area, a reduction in demand (perhaps from reduced migration), or a rising property market with valuations increasing.
Increasing yields, on the other hand, mean either a strong and high demand rental market with rising rents, or a falling property market with decreasing valuations - or both of these things.
To provide a comparison measure of rental yields, start with the current market valuation and the gross rent of your property, and compare this with similar properties in the area and the rental prices they’re currently fetching. This can help to provide you with a measure of typical rental yields in your area, and give you an idea of whether you’re overcharging or undercharging for rent.