Getting your strategy right – 4. Rental Yield

 

So you have decided to invest on a rental property. One of the things you need to know in managing your investment is to determine whether the property is generating positive cashflow or is negatively geared and to do this you need to understand the return you are getting on your investment — or the yield.  You can refer to our previous issues of Talking the Talk where we  discussed when a property is positive or negatively geared.   To determine whether or not your rental property is generating positive cashflow, you need to calculate its rental yield.

What is Rental Yield?

Rental Yield

Rental Yield = Gross annual rent / value of property

In finance, yield refers to the percentage of income return you gain from an asset.  In the context of property investment, rental yield is the percent of income one receives from a rental property.

How to calculate rental yield

There are two ways to calculate the rental yield—either using the property’s purchase price as the divisor, or the current value of the property.  Neither is incorrect and which of these you use may depend upon what you trying to achieve.  If you are only interested in how this property is performing based upon its current value then you would use current value. If you are interested in how this property is performing based upon your initial investment (or calculating a potential investment yield) then you would use the purchase price or expected purchase price.

So let’s look at a couple of examples.  If your property was purchase at $350,000 and you had it rented for $350/week:

calculate rental yield.001

If you were to base your calculation of the rental yield on the current market value of the property, let’s say that is $500,000, then you will be able to observe the trend of how the property is performing in terms of yield. If the rental yields you computed is decreasing, it could either mean there is an oversupply of rental property thus the fall in rents; or there is a rise in valuation of property and rental has not kept pace with the increased valuation.

market value.001

What’s a good yield?

It depends on your overall strategy and your strategy for this property in particular.  In some cases you may be looking for a high yielding property and your criteria may be rental yield > 10%. Rental yield, very generally speaking starts to indicate a positive cashflow property once yields are getting up around 2-3% more than the general interest rates.

There are other cases you may have invested in a particular property looking more for growth than cashflow and so you are willing to accept a yield of 5%.   Generally you should always be looking to maximise your yield, no matter what your strategy is as a higher yielding property will make life easier for you in terms of holding the property.

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