If you’re contemplating investing in property, understanding the rental yield is crucial in estimating potential returns. It aids in evaluating potential properties and areas for investment. Let’s delve into what rental yield entails, its calculation, benchmarks for a ‘good’ yield, and other essential factors to ponder.

What is Rental Yield?

Rental yield signifies the difference between the income generated by renting your property and the total investment costs. Typically presented as a percentage, a higher yield often implies increased cash flow and a more substantial return on your investment.

There are two primary types of rental yield: gross rental yield and net rental yield. These metrics differ significantly in their calculation, yielding varying figures.

Gross rental yield offers a straightforward calculation by comparing the yearly rental income against the property’s market value. While this metric aids in assessing a property’s overall investment potential, it might not provide a full realistic view of associated expenses.

In contrast, net rental yield furnishes a more precise estimation by accounting for ongoing investment property expenses, which at times can be substantial. Such expenses include property rates, insurances, property management fees, repair expenditures, legal fees, among others.

Regardless of whether one calculates gross or net figures, comprehending rental yield proves crucial for property investors. It aids in gauging the prospective ongoing return on investment and aligning it with property investment objectives. Moreover, tracking rental yield proves beneficial for annual property rental evaluations.

How is Rental Yield calculated?

The gross rental yield and net rental yield are calculated in distinct different ways, often presenting varied perspectives on the potential of an investment property.

The gross rental yield is calculated by dividing the annual rental income earned by the property value and multiplying by 100.

The net rental yield is calculated by subtracting the total annual operating expenses from the annual rental income earned. Then dividing by the property value and multiplying by 100.

An example of gross rental yield:

Michael purchased an investment property for $700,000.

His rent is at $600 per week.

The gross rental yield is calculated by taking the annual rental income ($600 x 52) = $31,200, divided by $700,000 x 100 = 4.45%.

The gross rental yield is 4.45%.

To calculate the net rental yield on a property is a little more complicated as you need to factor in the total operating expenses.  You use the same formula used to calculate the gross rental yield, and then subtract your expenses.

An example of net rental yield:        

Michael’s net rental yield is calculated by subtracting is total operating expenses for his investment property from his annual rental income.

$31,200 (600 x 52) – $6,200 divided by $700,000 = 0.035 x 100 = 3.5%.

The net rental yield is 3.5%.

How to Identify a Strong Rental Yield: What Constitutes a ‘Good’ Return?

Determining a satisfactory rental yield isn’t straightforward.  While a higher yield implies better cash flow, it might also compromise potential capital growth.  A property with an 8-10% rental yield could indicate undervaluation of the property, whereas a 2-4% yield might suggest overvaluation of the property.

Like many things in life, your approach to property investing comes down to having an investment strategy plan. A property boasting substantial rental yield can promise consistent income, yet its potential for capital growth might not be optimal. On the flip side, a property lacking rental yield might not yield the expected profit or cash flow, but it could deliver remarkable capital growth, thanks to its location in a thriving or growing area.

Every property investor dreams of uncovering the properties that boast the highest rental yields. There are a lot of things to factor in when conducting your research around property.  Expected rental income, rental yield, suburb price trends and demographics are all things to factor in.

For more information as to how you can start your property investment portfolio, please feel free to reach out to our team on 03 8351-5815, or [email protected].