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31 January 2019

Estimating Rental Returns on Investment Properties

No matter what investment strategy you use, calculating the potential rental return on an investment property is a key step in the purchasing decision process. The rental yield is an important indicator of how a property is likely to perform and the cash flow it will generate. So, whether you’re using a positive or negative gearing strategy, it’s a calculation that allows you to quickly decide if the numbers will stack up for you, and if you can afford to service a loan on that property.

In this article, we explain how to estimate the rental yield – an important first step before deciding whether an investment property is the right one for you. It should be noted that this is a general guide only – we recommend you consult a professional accountant and/or financial planner before proceeding with any investment or tax strategy.

So, what exactly is rental yield?

The rental yield is the rental income of a property, expressed as a percentage of its value. It can be calculated in gross terms (before expenses), or as a net percentage (with expenses factored in).

* Gross rental yield = (Annual rental income / Property value) x 100

Example: A property with a market value of $500,000 that returns a weekly rent of $500, or $26,000 a year ($500 x 52), would have a potential gross rental yield of:

($26,000/ $500,000) x 100 = 5.2%.

Overall, the gross rental yield offers a simple way to compare properties quickly. However, it does not take expenses into consideration. For that reason, a lot of investors use the net rental yield as a more accurate way of assessing returns.

* Net rental yield = [(Annual rental income – Annual expenses) / Total property cost] x 100

The net rental yield offers a clearer indication of whether you can afford an investment property, as it factors in your expenses. To work it out, you’ll need to calculate or estimate your total property costs and total annual expenses.

Total property costs could include:

  • The purchase price/ market value
  • Stamp duty
  • Conveyancing fees
  • Building and pest inspections
  • Loan establishment fees

Total annual expenses may include:

  • Property management fees
  • Rates and water charges
  • Strata levies (if applicable)
  • Insurance
  • Mortgage interest repayments.

Example: A property with a weekly rent of $500 ($26,000 a year), total property costs of $500,000 and annual expenses of $5,000 would have a net rental yield of:

= [($26,000 – $5,000)/ $500,000] x 100 = 4.2%.

Calculating the net rental yield can be tricky, given you need to understand the costs of buying and running an investment property. If you’re stuck, get in touch with a qualified accountant to help you crunch the numbers.

Yields versus capital growth

While strong rental yields are attractive, it’s important to remember they’re not necessarily the most important aspect of a property investment. Some investors opt for a lower rental yield but focus on buying property that is likely to experience capital growth. It all comes down to your investment strategy and goals.

If you’re considering an investment property purchase, I’m here to help. I can assist with arranging the right finance option to suit your investment strategy and goals. That includes everything from calculating your borrowing power to finding you a competitive investment loan for your needs. Please get in touch to find out more.

Gokee Arora
Mortgage Broker
iConnect Financial Alexandria

Gokee is available at gokee.arora@iconnectfinancial.com.au or by phone on 0424 952 673. You can also check out iConnect Financial here.

 

This article provides general information only and has been prepared without considering your objectives, financial situation or needs. We recommend that you consider whether it is appropriate for your circumstances and your full financial situation will need to be reviewed prior to acceptance of any offer or product. It does not constitute legal, tax or financial planning advice and you should always seek professional advice in relation to your individual circumstances.  Subject to lenders terms and conditions, fees and charges and eligibility criteria apply.

 

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