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Before you purchase an investment property, you can calculate the current rental yield to determine the profitability of the asset. You need to know the purchase price, the current estimated rental return for and cash flow as well as an estimate for operational expenses and average vacancy rates.
You want to keep an eye on your property’s rental yield to ensure that your investments are achieving the returns that are required and make any necessary changes.
For example, you might have more expenses than you expected and need to look at ways of reducing these overheads.
Rental Yield is a measurement that investors use to understand an income-generating asset’s performance over the course of a year. It measures how much cash your investment produces as a percentage of the asset’s value. In real estate then it is the rental income as a percentage of the property’s value.
When thinking about rental yield there are two terms you need to be familiar with: gross yield and net yield.
Gross yield is the return on your investment before expenses and vacancies are taken into account. Gross yield also does not take interest rates into account. Gross rental yield is a common metric to look at when analysing returns as it is simple to calculate letting you easily compare properties.
You take the ‘Annual rental income’ and divide by the ‘Property value’. Then multiply this number by 100 to get a percentage value.
Property value £600,000. Expected rent £3,000 a month.
£3,000 x 12 = £36,000 (annual rental income)
(£36,000 /£600,000) x 100 = 6% gross rental yield
Net yield takes into account any expenses or other outgoings such as maintenance costs, mortgage payments and insurance. Net yield is sometimes referred to as a rate of return. Because it takes into account these expenses it gives a more accurate picture of an investment’s cash flow than gross yield.
Take the ‘Annual rental income’ and subtract the ‘Annual expenses’. Then divide this number by the ‘Property value’ and then multiply by 100 to get a percentage value.
Property value £600,000, expected rent £3,000 a month and expenses/loss £6000.
£3,000 x 12 = £36,000 (annual rental income)
((£36,000 – £6000)/£600,000) x 100 = 5% Net Rental Yield
A rental asset should have a positive cash flow even after surprise expenses. You will want to calculate how quickly you can make a property positive after your initial expenses immediately after purchasing the property (eg. renovations).
This should be considered on a yearly basis as well as an overall basis to give yourself the best possible understanding of your property’s cash flow.
This is how long it will it take to breakeven on your investment. We work this out in our calculator from your cash flow, vacancy rate, and property purchase price. However, you should also consider mortgage interest rates when calculating this.
There’s no universal answer to this question. Determining the strength of an investment depends on numerous factors. For example, your overall investment goals and intentions. For example, if your goal is to live off the income from cash-generating assets then you will want a higher net rental yield.
However, if you are thinking long term and are aiming to build a sizable portfolio, then you might accept a lower rental yield.
Factors that may influence your decisions outside of rental yield calculations include market factors, such as local investment in the area, the current rate of appreciation, how long you’re going to old the property, average occupancy rates, your overall investment goals, and potential risks such as plans to open an airport nearby.
A high rental yield is certainly a good thing to have. However, the best investors consider as many facets of their investment as possible.
Is the property in a desirable location, near the town centre, near public transport?
How long do you plan to hold onto the property?
How much appreciation has the area experienced over the last 20 years? And how much can you expect over the holding period of the property?
What is your overall investment strategy? Build wealth for retirement? Supplement your existing cash flow?
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