Having strong rental yields within a property portfolio is essential for cash flow purposes. For many, the rental yield of a property is the most important factor when considering where and what to purchase. For others, they may focus on capital growth but understand the importance of having a high-yielding property.
What is a rental yield?
A rental yield is simply the rental return you receive from your property divided by the purchase price of the property (per annum). There are two types of rental yields, gross and net. A gross rental yield is simply rental income vs purchase price. Net rental yield is the same but includes expenses associated with the property. A gross yield can be used to easily compare different properties. A net yield will give more accuracy to the true holding costs and cash flow of a property.
You may notice that some property listings include a rental yield within the advertisement of the property. This will likely be because the property is currently tenanted or to advise what the property could be rented for. This helps the potential buyer understand what return they would receive via rent if they purchased that particular property.
How is it calculated?
To calculate a rental yield is quite simple. To calculate a gross yield, you take the expected rental amount times it by 52 (number of weeks in a year) and divide it by the purchase price. For example, a 750k property may achieve a rent of $600 per week. So, we take the $600 and multiply it by 52 which equals $31,200 (annual rent). We then divide $31,200 by 750,000 which gives us 0.0416. This means the property has a 4.16% gross rental yield.
To calculate the net rental yield we follow a similar formula but have one additional step. Let’s assume we are taking into account all expenses except the loan repayments (as this would change depending on the deposit amount and interest rate). Using the same scenario above the calculations would be as follows. The purchase price of a property was 750k and the property is rented for $600 per week. The property has 2k council rates, 1k insurance, 2.5k property management fees, and an average of $500 of maintenance per annum. This totals 6k in expenses and is reduced from the rental income. Therefore, the rental income is 600 x 52 – 6k = 25.2k. We now take this number and divide it by 750k which gives us a 3.36% net rental yield.
In most cases, agents selling a property will give the gross rental yield. This can sometimes be misleading as it doesn’t take into account additional holding costs. So, you may find using a net rental yield is a more accurate way to calculate the true yield on a property. This would always give a lower yield but have a greater reflection on what rental return would go into your pocket per year. It may also be more reflective when comparing different asset classes with the property.
Why is it important?
A rental yield is important because the metric allows investors to compare all properties on the same playing field. A 1-million-dollar property is likely going to have a higher rental return than a 500k property. However, this is not comparing both properties fairly. The million-dollar property costs twice as much and therefore should achieve a higher rent. Therefore, by using a rental yield the investor can compare the properties proportionally to their purchase price.
How to increase yield?
So now that we know what a rental yield is and how it is calculated how do we increase it? Firstly, the distinction needs to be made on whether you are looking to increase your yield pre or post-purchase. If you are looking for a higher yield before purchasing a property, then you have more room to secure the property that is or can offer a high yield. If you already own a property, then you still have scope to improve this yield, but it is more limited post-purchase.
There are numerous things to look for when wanting to find strong yields pre-purchase. The following are examples of what an investor could consider when looking for a high-yielding property.
- Renovated usually leads to higher rent. If a property is renovated, then it will likely demand a higher rent in the market. Therefore, if you purchase a renovated property, you will achieve a greater rental yield. Although, note, renovated properties may cost more which could impact your yield.
- The bigger the better. A bigger property both in size and the number of bedrooms, bathrooms, and land will demand a higher price. It is pretty self-explanatory, but a 4-bedroom 2 bathroom will nearly always demand a greater rent than a 3-bedroom 1 bath in the same suburb. Again, this will likely come with a higher purchase price so this is something you may want to consider.
- Meet the market’s demands. In some market’s certain types of properties or accessories may warrant a greater rent. For example, properties in certain locations with large sheds can add $10, $20, or $50 more per week. Other markets may have strong desires for covered parking. You will want to determine what this value-added factor is and search for properties with this.
- The lower the price the higher the yield. Property prices and rental yield have an inverse relationship. That means as property prices rise rental yields fall. This can be seen right across the country as million-dollar properties usually offer 2-4% yields will 300k properties can comfortably achieve 5-7% rental returns. This is likely because even though property prices continue to rise salaries and wages have been quite stagnant over several years. This means achieving similar rental yields is not sustainable as property prices rise. This is not to say rental prices don’t rise too, in fact, they do and rise with property prices but not to the same extend. This is an affordability constraint. As more and more properties surpass the million dollars mark it would be unrealistic to assume they could, on average, sustain a higher rental yield. For example, a 5% yield on a million-dollar property would equate to around $1000 per week. Therefore, purchasing cheaper properties will likely provide the investor with a greater rental yield.
Increase rental yield
Once a property has been purchased there are numerous things an investor can do in order to increase the rental yield they are already receiving.
- As discussed previously, an investor could renovate their property in order to achieve a greater rent. In doing so they will have a higher demand in the rental market and demand more rent per week.
- An investor can increase their rent at the end of a rental agreement period. Each year the investor may bump up their property/s by $5-10 or to align with the current rental market and this can increase their yield. This of course assumes that the rental market has been growing.
- Change the rental demographic. If the investor can think outside the box and has the property to do so they may wish to alter the type of rental they offer. This could mean making their property a short-term rental with the likes of Air BnB or Stayz. Alternatively, they may decide to rent the property room by room increasing the total rental amount. Changing the property from a stock standard rental to an alternative rental property can significantly increase the rental yield if managed correctly.
Having a strong rental yield goes a long way in the successful management of a property portfolio. There are numerous things to look for if you want to increase your rental yield. Each consideration can either be employed pre or post-purchase. Consider each of these potential options if you wish to increase your cash flow position.