In the world of property investment, there’s one measure that can often make the difference between a profitable venture and a less successful one: rental yield.
In fact, understanding how to calculate rental yield is a critical step in assessing the potential returns of a property investment.
But what is it, and more importantly, how do we calculate it?
The answer lies in the fact that it allows investors to compare properties and markets, providing an overview of its earning potential.
Here’s what you need to know.
Understanding What Rental Yield Is
In simple terms, rental yield is the annual rental income that your property generates, expressed as a percentage of its value.
But why is understanding how to calculate rental yield so important?
A higher rental yield percentage indicates that a property is generating a larger amount of income relative to its market value. For an investor, this means you’re receiving more rental income for every dollar invested in the property, making it a more efficient use of your investment capital.
So, when you’re weighing up whether or not to buy a property, it’s a good idea to consider what the rental yield is.
Generally, there are two types of rental yield calculations: gross rental yield and net rental yield.
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What is the Gross Rental Yield of an Investment Property?
Gross rental yield provides a basic snapshot of a property’s potential return on investment. It’s calculated by dividing the annual rental income by the property’s market value and is often used as a quick reference point for comparing potential investment properties.
However, the gross yield does not consider the ongoing costs of owning and maintaining a rental property, such as property management fees, insurance, repairs, and maintenance.
What is Net Rental Yield?
Net rental yield provides a more realistic view of a property’s return as it factors these ongoing costs. It’s calculated by subtracting these annual costs from the annual rental income and then dividing them by the property’s market value.
The resulting percentage clearly indicates the actual income an investor can expect to receive from the property.
What Factors Affect Rental Yield?
When comparing rental yields for different investment properties, you need to consider how the following factors will impact the property’s overall performance:
Properties in high-demand areas, such as those close to the city centre, transport hubs, and popular amenities, tend to generate higher rental yields. On the other hand, properties in remote or less desirable locations may see lower rental demand and yield.
The type of property you invest in can also affect the rental yield. Property types, such as houses, apartments, or townhouses, may have varying rental yields based on demand and maintenance costs.
For example, houses typically have larger land components, potentially commanding higher rents and positively impacting rental yield.
Comparatively, apartments and townhouses may appeal to tenants seeking low-maintenance living, increasing demand and rental yield.
So, you need to consider the size and features of your property, including the number of bedrooms, bathrooms, and living spaces, in relation to rental demand.
The concept of rental yield is closely tied to the basic principles of supply and demand. When the demand for rental properties in a certain area is high and the supply is limited, this puts upward pressure on rental prices.
Investors are then able to charge higher rents because there are more prospective tenants competing for fewer available properties.
This rent increase can consequently lead to higher rental yields.
But you need to remember that rental demand and prices can fluctuate based on various factors, including economic conditions, employment rates, population growth, and even changes in local amenities.
To give you an idea, the average rental yield of houses in Sydney, New South Wales, was 2.87 percent in the fourth quarter of 2022.
While high rental demand can potentially lead to higher yields, it’s essential to consider these potential variables when making property investment decisions.
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How to Calculate Rental Yield
As we previously mentioned, both gross and net rental yield percentages provide valuable insights but serve different purposes.
Gross yield is a useful tool for quick comparisons between properties, while net yield offers a deeper, more accurate understanding of potential returns once costs are considered.
Either way, it’s good to know how to calculate both.
Calculating Gross Rental Yield
Follow the next three steps to calculate the gross rental yield of a property:
Step 1: Determine Annual Rental Income
To start, you need to determine the property’s annual rental income. Here’s how:
- Identify the weekly rent you can reasonably for the property.
- Multiply the weekly rent by 52 (the number of weeks in a year) to obtain the annual rental income.
For example, if the weekly rent on a property is likely to be around $500, the annual rental income will be:
$500 × 52 = $26,000
Step 2: Determine Property Value
Next, you need to find out the property’s current market value. You can do this by:
- Researching online property listings to get an idea of the property’s market value.
- Consulting with a local estate agent for a professional opinion.
You can also use the property’s purchase price as its value, especially if it was recently purchased or market conditions have remained stable.
Step 3: Calculate Gross Rental Yield
Finally, it’s time to calculate the gross rental yield. You can use the following formula:
Gross Rental Yield = (Annual Rental Income / Property Value) × 100
Using the example from Step 1, let’s say the property value is $650,000. The gross rental yield will be:
($26,000 / $650,000) × 100 = 4%
How to Calculate Net Rental Yield
The following steps will guide you through the process of calculating the net rental yield:
Step 1: Calculate Annual Expenses
First, you need to calculate the estimated annual expenses of owning this property. These expenses include:
- Property insurance
- Maintenance costs
- Vacant period losses
- Agent and advertising fees
- Mortgage costs
Here’s an example showing the breakdown of expenses:
Annual property expenses
Step 2: Calculate Net Rental Income
Calculate your net rental income by subtracting the total annual expenses from the gross rent. Here’s an example:
- Annual gross rent: $26,000
- Total annual expenses: $13,100
- Net rental income: $26,000 – $13,100 = $12,900
Step 3: Calculate Net Rental Yield
Finally, to calculate the net rental yield, divide the net rental income by the property value and multiply it by 100.
- Property value: $650,000
- Net rental income: $12,900
- Net rental yield = ( $12,900 / $650,000) x 100
- Net rental yield = 1.98%
What is Considered a Good Rental Yield?
A “good” rental yield can depend on various factors, including the following:
- The real estate market in the region
- Type of property
- Individual investment strategies
- Risk tolerance
- Market conditions
However, as a general rule of thumb in many markets, a gross rental yield of 5-8% is often considered good.
Here are the key takeaways from this blog:
- Rental yield is a key metric used in property investing as it represents the annual rental income from a property as a percentage of its market value.
- A higher rental yield means a larger income relative to the property’s market value, making it a more efficient use of investment capital.
- There are two types of rental yields: gross and net.
- Gross rental yield is a quick snapshot of a property’s potential return and doesn’t account for the ongoing costs of maintaining the property.
- Net rental yield provides a more realistic return view by considering these ongoing costs.
- Factors affecting rental yield include location, type, and demand.
While understanding rental yield is essential to property investment, it’s just one aspect of a multi-faceted decision-making process. Other considerations include property market trends, growth projections, and, most crucially, financial aspects like mortgage terms, rates, and conditions.
You must ensure you get the right investor loan structure that aligns with your financial situation and investment goals.
At The Mortgage Agency, our mortgage brokers are dedicated to helping you navigate these complexities, ensuring you make the most informed and beneficial decisions. Contact us today to discuss your property investment aspirations and how to optimise your mortgage.
We’re here to help you succeed in your property investment journey.
Personal Finance Preparation
As we navigate this landscape of rising interest rates, the cornerstone of our journey lies in robust personal finance preparation.
Assessing Financial Goals
First, evaluate your current financial goals and determine how rising interest rates may affect them. Remember, higher interest rates can impact your borrowing costs and investment returns. It’s possible that you’ll need to make some changes to your plans in order to stay on course towards achieving your financial goals.
When reassessing your goals, consider the potential implications of higher interest rates on your:
- Personal loans
- Savings accounts
Budgeting and Saving Strategies
As you gear up for the impact of rising interest rates, taking a closer look at your budget and savings tactics is vital. Let’s explore some valuable advice to guide you on this path:
- Create a detailed budget that outlines your income and expenses. Be sure to account for the potential for increased mortgage or loan repayments.
- Prioritise building an emergency fund to help buffer yourself from unexpected expenses or income disruptions.
- Cut back on unnecessary expenses and focus on saving money where possible. This can involve shopping smarter, managing energy consumption, or exploring cheaper alternatives.
- Take advantage of high-interest savings accounts to maximise your savings potential.
Managing Debts and Investments
Another pivotal piece of the puzzle when confronting higher interest rates is proficiently overseeing your debts and investments. Here are some suggestions:
- It is recommended that you consider refinancing your mortgage or other loans to secure lower interest rates before they increase significantly.
- If you’re contemplating buying a house, be mindful of potential rate increases and consider buying sooner if it suits your financial situation.
- For debt repayment, focus on high-interest debt first, as higher interest rates will compound your debts faster.
- Review your investment portfolio to ensure it remains well-diversified and can weather the implications of rising interest rates. This may involve adjusting your allocation of stocks, bonds, and cash as necessary.
As a homeowner grappling with the reality of rising interest rates in Australia, there are a few things you need to keep in mind when preparing for the new high interest rates.
For example, during the COVID-19 pandemic, many of us took advantage of the low interest rates to fix our mortgages. It was a good move at the time, giving us some financial stability in a very uncertain period.
But now, things are changing.
Those fixed-rate periods are set to expire, and we’re looking at much higher interest rates because of the recent cash rate hikes.
One of the first steps is to take a look at your personal financial situation, as we discussed earlier.
But another option is to consider refinancing your mortgage.
Refinancing allows you to switch to a new mortgage with a potentially better interest rate or more favourable terms. Consider the following options:
- Switch to a fixed rate: If you currently have a variable-rate mortgage, you can refinance and lock in a fixed rate for a specific term. This can provide repayment stability during a period of rising interest rates.
- Consolidate debts: If you have multiple loans—such as credit card debt or personal loans—consider consolidating them into your home loan. This can lower your overall repayment burden and simplify your finances.
- Negotiate a better rate: Speak with your mortgage broker to see if they can negotiate with your lender to offer you a more competitive rate based on your financial history and market conditions.
But before refinancing, assess any fees or penalties associated with switching loans and consider the long-term impact on your mortgage. Speaking with a mortgage broker to guide you through the process and help you make well-informed decisions is always a good idea.
Remember, staying informed and proactive can make all the difference in navigating Australia’s new high interest rates.
Preparing for high interest rates in Australia requires a multifaceted approach, encompassing personal finance management, debt and investment oversight, and homeownership considerations.
Here are the key takeaways:
- Understand the factors behind high interest rates.
- Be aware of the impact on the economy.
- Prepare your personal finances, including reassessing financial goals and implementing budgeting and saving strategies.
- Manage debts and investments by considering refinancing options and focusing on high-interest debt.
- Consider homeownership considerations, including refinancing and consolidation options.
Remember, as we navigate these changing financial waters, staying informed and taking decisive action are crucial.
It can take an estimated 3-6 months to adjust and prepare for these changes fully, but with the right steps, you can confidently handle the new high interest rates in Australia.
If you need help investigating your refinancing options, book your free discovery session with The Mortgage Agency today.