Before I start, I should mention my easy Rental Yield Calculator here so you can verify any investment property yield quickly.
Whenever you are researching an investment property to buy, it is important to determine the rental yield (sometimes known as rental return) of the property. The rental yield will be a big factor in how much cash-flow you receive (or lose) whilst owning the property.
So what is rental yield and how to calculate rental yield? Rental yield is simply a ratio that shows the amount of rental income received in a year relative to the purchase price of the property. For example, if your property would rent for $1000 per month, you would times that by 12 to get the annual income figure of $12,000.
You then divide the $12,000 by the potential purchase price, in this case we will make it $240,000 to get the yield ratio (and then multiply by 100 to get the percentage).
12,000 divided by 240,000 equals 0.05 or 5%.
So our rental yield in this example is 5%, which is a common rental yield.
What does this tell us?
The number 5% may not mean much, unless you know what interest rate you will be paying on the mortgage. For ease of demonstration, let’s assume you are borrowing the full purchase price of $240,000 at 7% interest rate. So we have:
Income = 5% of purchase price.
Mortgage Interest Expenses = 7% of purchase price.
So income minus interest expenses equals -2%.
Excluding all other expenses, we can quickly and easily see that our net cash-flow for this property is -2% of the purchase price. -2% of $240,000 equals -$4,800 per year net cash-flow. It’s a cash loss so if you were trying to buy a positive cash-flow property, you would need to find a property for the same price but a significantly higher rental return.
This is a rough guide as it does not include council fees, insurances, property management fees etc but interest payments are by far the largest expense in owning a property so it is a pretty close figure.
Calculating the rental yield of any potential property will quickly allow you to determine if the property is going to have the desired cash-flow that you require to make a sound investment. Of course, this is only one of many factors you will consider when looking at an investment but it is a very important one.
Rule of Thumb
An even quicker way of calculating rental yield without getting out the calculator can be done with this simple rule of thumb.
Any property where the purchase price is 1000 times more than the weekly rent, you will have a yield of 5.2%.
Purchase Price = $650,000
Weekly Rent = $650
Rental Yield = 5.2%
Purchase Price = $234,000
Weekly Rent = $234
Rental Yield = 5.2%
Try it yourself, it always works like this. Don’t forget to multiply the weekly rent amount by 52 to get the annual income before dividing by the purchase price.
So now you can look at a property listing and if it’s weekly rent potential is the same number as the purchase price (times by 1000) then you’ll instantly know the yield is around 5.2%. Then if the rent is slightly higher or lower than that, you can guestimate the approx. yield without thinking about it too much.
Although, at the end of the day when you are seriously looking at a property, you’ll want to do the calculations properly so that you know where you stand. This rule of thumb is more suitable when you are looking through dozens of properties and trying to narrow down your options.