What is yield and how do you calculate it?

What is yield and how do you calculate it?

October 23, 2020

When it comes to calculating the value of an investment property one thing you will be hearing time and time again is talk about yield. Simply put, the yield is what you expect to get back. Your future income.

Yield is what seasoned property buyers use to determine if a property will be a valuable investment.

Typically, the yield is measured as an annual percentage so you can easily compare your yearly ongoing costs (rates, insurance, maintenance etc.) and any incurred interest against your expected returns to get your profit figures.

Returns and yields are different and both important when looking at the value of a potential investment property. The difference is that yield takes into account future economic situations, which might be very different from past performance.

Don't get returns and yield mixed up. Returns are calculated by looking into the history of the property using hard facts and figures, while yield relies on estimations, predictions and room for error for how the future might play out. Returns are easy to determine because all the expenses and income are final and complete.

Different types of investment properties offer different financial strengths. Some have a low yield but high capital gain, meaning that the land will be very valuable later on. In these cases, a low return may be worthwhile overall, especially if the investor does not have to rely on property income to make loan repayments. Other properties might have low yield (or zero yield to start with) but are worthwhile for their infrastructure potential. Capital gain is not factored into yield, the yield is only the money earned directly from owning and running the asset, not selling it.

You must know the financial strength of the property type you are interested in so you are looking for the right type of investment, it will save a lot of energy if you focus your research in the right direction.

Usually, though, most investment properties are aimed at high yield, and this in most cases will be the deciding factor when it comes to an investment property purchase.

You need to be careful that you factor in all the expenses because these can be high, taking a huge cut from your income. This is especially true in an apartment type setting or shopping centre where there are compulsory fees. If the calculations you have are for gross rental yield you need to be aware that this doesn't take any expenses into account.

Gross rental yield is not the figure you need to be making your value assessment on, you need to be looking at the net yield.

Look out for initial purchasing fees. Purchasing a property comes with fees, stamp duty and administration costs that you need to factor as part of your running expenses. Even though these costs are one-off they are still are a large contributor to your expenses and will be am important deduction to accurately measure your net yield.

Your conveyancer fees, transfer fees, stamp duty and building inspection costs will all need to be factored into your expenses.

Known expenses. Your set up and administration costs will be part of your known expenses. They have fixed prices and come into play at fixed times during your ownership. Council rates, property management fees, ongoing maintenance for gardens and building care, insurance and property fees are all easy to calculate and plot out over the year.

Some of the expenses you'll be facing will be unknowns. How much time the property will stand vacant, repairs and service replacements, like water heaters or emergency plumbers, how often you will need to pay advertising fees, or if you'll need to replace the locks. These costs will be unknown but estimate them as best as you can. You will also need to assume in your calculations that rates and service costs will increase year to year.

It is important to research vacancy percentages in the local area, and if you can, with the building history to assess how much time you may go without rent.

When talking to your property agent be sure to get all the figures on both the return and yield. As well as the numbers themselves, you need to have an understanding of where these figures have come from. Across what periods? Are they calculated on an annual basis?

Hear the term hard yield or soft yield while out researching? Yields are said to be hardening when the yield is dropping back or reducing. This is something that happens when property prices increase. A softening yield is a term used when the yield increases.

How To Calculate Yield

It is best to look at an annual yield. To do this:

A: Determine the annual rental income (weekly rental x 52). Deduct from this an estimated amount of lost rent (vacancy periods) and all expenses associated with owning a property for one year.

B: Divide total A by property value

C: Multiply total B by 100

For example. You buy a property for $495,000 and rent it out for $386 a week. You factor the yearly expenses to be around $3,000.

A: ($386 x 52) $20,072 – $3,000 = 17,072
B: 17,072 / 495,000 = 0.03448
C: 3.45%

This is your net yield.

For your gross yield, you don't factor in the expenses.

A: Multiply the weekly rental by 52 to get the annual rental
B: Divide the annual rental by the property value
C: Times the total by 100

Using the same example above

A: 20,072
B: /495,000 = 0.0405
C: Gross yield = 4.05%

The higher the yield, the higher the percentage. Just remember, this doesn't mean you will get a great capital gain, just because the yield is high, in fact, with most investments you have to choose one or the other, you can rarely bank on both. Please take into account that the right property management can have a big impact on sustainable rental returns so there are plenty of factors to weigh up and consider as part of your investment plan.

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