If you have decided to invest in real estate for the first time or are looking to expand your portfolio, what are the key factors that should inform your property choice? Calculating rental yield is a useful way to compare properties based on potential short term returns and make an informed decision on which investment best meets your financial targets. In addition to yields, you should look at other factors that might affect rental returns such as vacancy rates and rental growth in the area, and assess the property’s long term capital growth potential.
What is Rental Yield?
Rental Yield is expressed as a percentage and compares the income from a property against the costs associated with owning it. Rental yield can be considered in two ways – gross rental yield or net rental yield (which includes outgoings into the equation). Gross rental yield is calculated as:
Gross rental yield = (Annual rental income / Property value) x 100
Annual rental income is weekly rent x 52 and Property value can be the purchase price, current estimated market price or potential price. It’s important to note that if prices rise but rents remain static (as is the case at the moment), then the gross rental yield will fall.
This very basic calculation is useful to compare properties against each other, but does not reflect the reality of the investment returns you will receive. For a more accurate estimate, you need to look at Net rental yield. Net rental yield is calculated as:
Net rental yield = [(Annual rental income – Annual expenses) / Total property cost] x 100
Annual rental income is weekly rent x 52 and Annual expenses include items such as strata fees, management fees, insurance, interest on loan, Council rates, repairs and maintenance and depreciation.
Total property cost is the price of the property plus initial loan costs, building, inspection and strata reports, stamp duty and legal fees.
Calculating potential net rental yield, even if it is not absolutely accurate, also offers you a more accurate figure to compare properties against each other and also against other investment options such as shares or even bank interest rates.
What Else Will Impact Yield?
Rental trends, vacancy rates and median price growth are all important in gaining an overview of the market you’re looking at – and potential performance of your investment. Vacancy rates will impact market rents and occupancy levels, as well as indicating an oversupply that might affect the sale price. Higher vacancy rates mean there is more choice for tenants, and might lead to rent discounting. Many property research groups produce regular updates on market rents and vacancy rates in cities and regions, and more detailed reports on specific areas. Two leaders in this field are CoreLogic with info at http://www.corelogic.com.au/news/type?q=rent or SQM Research with information on yields available at: http://sqmresearch.com.au/property-rental-yield.php?t=1 and vacancy rates and vacancy trends in a general region, City or specific suburb are available at: http://sqmresearch.com.au/vacancy.php?t=1
Where will you find the best yield?
There are plenty of free and purchasable reports available which identify suburbs that are currently producing or have potential to produce the highest yield, such as the realestateinvestar.com.au Top 50 Growth Suburbs, and SQM Research’s Gross Rental Yield which compares vendor asking prices against asking rents at: http://sqmresearch.com.au/property-rental-yield.php?t=1
Positive or Negative Gearing?
The decision as to whether you want the property to be Positively Geared or Negatively Geared depends on your financial circumstances and investment goals. Negative gearing means the property’s outgoings are higher than income, but these losses and depreciation can be offset against the tax on your salary. Positive gearing provides you with income from your investment. It’s a decision you should discuss with your financial advisor, bearing in mind that you cannot depend on capital gains in the short term to offset monthly or annual losses.
Is Yield the Best Tool for Assessing an Investment?
Yield is obviously only one factor when assessing an investment, with the other main consideration being capital appreciation potential. It is generally accepted that investors need to hold properties for at least five years in order to achieve a net profit, once purchasing and selling costs and capital gains tax are taken into account. There is plenty of information available to look for capital gains potential, such as The Price Predictor Index 2016 from Hotspotting.com.au which analyses sales across Australia, identifies growth patterns and areas of potential growth. However, in a slowing market with no guarantee of substantial capital growth, rental yield is probably the most useful benchmark for investment decision-making.
Find a Property that Stacks Up
There are plenty of property research sites where you can find free information or paid, detailed reports on every property market in Australia. At Forsyth we’re always happy to talk to you about potential investment in real estate, keep you up to date with what’s on the market and provide you with costs and potential rental on a property you are considering buying for investment purposes. Give our sales team a call and we’ll help you find an investment that stacks up for you.
Calculate Gross Rental Yield and Net Rental Yield
Discuss negative and positive gearing with your financial adviser
Research factors that might impact rents such as vacancy rates
Assess capital gain potential