In the real estate industry, there are several ways to profit from properties, but renting is one of the most common and sustainable methods. Now, if you’re planning to get into rental income investments or looking to scale your current assets, how exactly could you determine whether a property is or can be profitable? This is where the rental yield comes in, which is a performance indicator that provides insight into how much income a property can generate. Want to know how the rental yield works? Here’s a guide on what the rental yield is, why it matters, how to calculate it, and how you can improve it over time.
Key Takeaways
- Rental yield is a key performance indicator that shows how much annual rental income a property generates relative to its purchase price or market value.
- Gross rental yield only considers annual rental income and property price, while net rental yield provides a more accurate measure by including operating expenses in the equation.
- The gross rental yield is ideal for preliminary property screening, while the net rental yield is typically used to determine the property’s true profitability.
What Is Rental Yield?
So, what is the rental yield? Coming from our time in San Antonio property services, we know that the rental yield is presented as a percentage that displays the expected annual rental income of a property. In other words, you get to see how much return an income property can generate per year relative to its purchase price and market value. For example, if a property costs $200,000 and produces $20,000 in annual rent, the rental yield is 10%.
At its core, the rental yield is a useful tool that you can use to quickly assess and compare multiple properties. But before you do, you need to understand that there are two types of rental yields – gross and net. We’ll discuss each one more in the next sections.
How to Calculate Gross Rental Yield
Let’s start with the gross rental income. Gross rental yield is only concerned with the rental income and the property price. This is without considering the other expenses involved in running a rental income property. The formula for gross rental yield (in percentage) is simply the annual rental income divided by the property price and then multiplied by 100.
Gross Rental Yield = (Annual Rental Income/Property Price) x 100
For example, let’s say that the property costs you $300,000 to acquire. Then, you have it rented out for $1,800 per month. This gives you an annual rental income of $21,600. With these numbers, your gross rental yield is 7.2%.
How to Calculate Net Rental Yield
The net rental yield takes the gross rental yield and includes the additional costs and expenses that landlords and rental owners incur in running a rental income property. We’re talking about management fees, taxes, maintenance, and the like. The formula is the annual rental income minus the annual operating expenses, which is then divided by the property price. Then, you multiply the answer by 100 to come up with the percentage net rental yield value.
Net Rental Yield = ((Annual Rental Income – Annual Expenses) / Property Price) x 100
Let’s use the same example above with the property costing $300,000. However, this time, we’ll take into account the property’s operational expenses costing $6,000 annually. With this, we can come up with the net rental yield of 5.2%.
Gross vs. Net Rental Yield: What’s the Difference?
The gross and net rental yields serve the same purpose, which is to give an easy way to determine the profitability of various properties. However, they do so at different levels.
First, the gross rental yield is used for quick calculations, making it ideal for initial property comparisons. However, it ignores expenses. Therefore, you can’t rely on it solely to dictate your business strategies and decisions.
On the other hand, the net rental yield gives a more accurate view of the profitability, as it measures the same parameters, but also addresses operating expenses. Because of this, the net rental yield is commonly used for long-term investment analysis.
Generally, it is more common for rental owners to use gross rental yield during the screening process. Then, they will later calculate the net rental yield before finalizing their decisions. This is because a property might appear attractive based on gross yield but become less appealing once maintenance costs, property management fees, and vacancy risks are included.
What’s a Good Rental Yield
To determine a good rental yield for a property, you have to know the state of the local rental market. The most important factors to consider include the demand for rentals and the prevailing property prices.
For places with expensive properties, it is fairly common to see rental yields ranging from 3% to 5%. On the other hand, a stable market with a good balance of demand and relatively affordable housing commonly enjoys a higher 5% to 8% yield.
Let’s use San Antonio as an example – with a median monthly rent and home price of $1,600 and $285,000, respectively. From here, we can assume a median rental yield of around 6.7%, which is a strong rental income performance.
However, it’s important to look beyond income and expenses. Higher rental yields may reflect underlying market factors, such as competitive rental markets, rising costs, and the like.
Common Mistakes to Avoid While Calculating Rental Yield
A property’s rental yield shows you the projection of your income. If it’s inaccurate, then you might face financial troubles along the line. Taking this into consideration, it’s important that you take conscious steps to avoid common mistakes when calculating the rental yield. For example, for net rental yields, it is critical to have all expenses accounted for (maintenance, insurance, taxes, etc.). Otherwise, you may be led to believe you’re generating more than you actually are.
Another common pitfall in rental yield is forgetting vacancy risks and their implications regarding income generation, cash flow, and tenant turnover costs. Realistically, rental properties don’t always have a tenant all the time. So, if you calculate your yield annually but fail to acquire a tenant for a significant period, then your projection will be inaccurate.
Improve Rental Yield with Bay Property Management
Improving rental yields comes down to the proper management of your property. Particularly, minimizing operating costs, optimizing processes, and positioning yourself competitively in the rental market. This is where a professional property management company, like us at BMG, can make a huge difference. With our experience, we can help you minimize vacancies, control operating costs, and streamline your day-to-day operations. Interested? Contact us today and let’s get started.
