Your weekly 'How To': Calculating rental yield
Every investor should be able to work out some of the most crucial aspects of property investing themselves - even if they're not a mathematician or financially trained.
Each week we will be looking at a different 'How To', from renovating to those niggly sums that you're used to Googling.
The Rental Yield
A number of rental yield calculators exist online, and while it's definitely useful to be able to quickly have a machine spit out a number, it's worth knowing the calculations that are happening behind the scenes.
What is it calculating?
Your rental yield is a quick number that lets you know how much rental return you are achieving compared to the asset's value. A $500,000 property returning $200 a week will have a worse rental yield than a $200,000 property achieving the same income. Regardless of whether you invest for cash flow or capital gains, rental yield is likely to be of interest to you.
How do I work it out?
Take your property's purchase price, and the yearly rent (weekly rent times by 52). Divide the yearly rent by the purchase price and times the result by 100 to get yourself a percentage. This percentage is your rental yield.
If you haven't purchased the property yet then using a rental estimate (from a property manager, or from your own comparisons made) and a price estimate should be able to give you a close comparison.
Example:
Purchase price: $500,000
Weekly rent: $495
Rental yield: 5.15%
Be aware
If you are provided a rental yield 'estimate', always ask for the basis of the purchase price and rent assumed behind the calculation. Note that the common calculation, as above, does not allow for any vacancies at all. You should be aware of the likelihood for vacant periods and how this will affect the return.
A quick note
A number of readers regularly ask why the gross rental yields (the above calculation), rather than net rental yields are commonly used. Net rental yields can be useful for working out the minutiae of an investment, however gross rental yield is a broad-sweeping calculation that is comparable across investments and quickly provides a return that isn't based upon an individual.
Everyone's net will be different (as it depends on your LVR, taxable income, strata levies, and a number of other considerations) and therefore it isn't practical for news outlets to use this figure unless in specific case studies. Similarly, costs can change over time and for reasons outside of your control (for example, increasing insurance premiums) as can the return (unexpected vacancies).
To calculate your net rental yield, take the annual expenses away from your rental income and then undertake the same calculation.
Now that you know how to calculate a rental yield, tomorrow we'll flesh out how to use this statistic in a little more detail and why you want to know the number before you purchase.