What is gross rental yield?

When I bought my first home, why did I not consider this? Well, buying your own home has the purpose of living in it, where you’re not considering it as an investment and hence why people say “you should not consider your home to be an investment”. That being said, you can leverage off your first home to buy an investment property. I’ve written a blog on how to buy an investment property with no deposit here. 

The gross rental yield on a property is a term that most people ask and talk about, using common phrases below:

“What’s the rental yield on that rental property?”

“That rental yield is so LOW!”

“WOW, how did you manage to find such a HIGH rental yield?”

The term gross rental yield is a measure on how much rent is coming in a year as a percentage of the property value. 

How to calculate gross rental yield?

Below is a formula:

As an example, let’s make the following assumptions:

• $750,000 is the property value (Purchase price or estimated market value)
• $33,800 is the annual rental income ($650 per week in rent)

Plugging in those numbers, the gross rental yield is:

Therefore, gross rental yield in the above example is 4.50%. 

Why is gross yield important?

When buying an investment property, it is critical that you know your numbers. Without this, you’re buying an investment with emotion and taking a gamble. What the yield calculation will give you is an instant indicator on whether it is worth your time and money. 

When you’re at an open home and looking for a property to invest in, typically there will be a rental appraisal and you can work out what you’re willing to pay for the property. From those two numbers, you can determine the Gross Rental Yield. In an instant, you’ll know if this property has a good return on investment. 

This is a simplistic approach and has some limitations. Another number that property investors look at is the Net Rental Property Yield. This calculation also accounts for the expenses such as rates, insurances, maintenance, property management fees & interest rates. I’ll discuss more on Net Rental Yield below. 

What is considered a good or high Gross Rental Yield?

This is quite subjective, because one person may value the property higher or lower than what you think and skew the numbers. In the current climate of extremely low-interest rates, as of October 2020, the lowest 1-year rate at ANZ is 2.49%. This will give you a benchmark to work on. 

But as mentioned above, the Gross Rental Yield doesn’t factor in expenses. Using the above example of 4.50% vs 2.49%, on paper it looks magic as you’re making money because the Rental Yield is higher than the mortgage. But you must dig deeper for more information, hence the Net Rental Yield is important to consider before jumping the gun on the investment property. 

Generally, most properties now in New Zealand are cash flow positive due to the low-interest rate environment we are in. Most property investors are aiming between 4% - 5% in the bigger cities such as Auckland. Looking at the provinces and smaller cities, yield can be as high as 6% - 10%+.

However, there are trade-offs of having a larger Gross Rental Yield, such as the growth of capital gains. There is a balancing act between the two. Lower rental yields do typically have a larger capital gain growth because of the larger population and so demand is higher. Whereas the opposite is true for higher rental yields. 

There are many factors at play. You will need to determine if you want to go for more of a high yield type property or a low yield property but with a potential of larger capital gains. One way of figuring this out is determining what stage of life you are at. If you want to generate wealth, capital gains could be the path, then eventually switching it to more higher cash flow yield type properties once you’ve generated the wealth to do so. 

What is Net Rental Yield?

Net Rental Yield is factoring in the expenses when buying your investment property. So similar to owning your own home, you’ve got these typical expenses to account for:

• Council rates
• Insurance
• Maintenance costs 
• Property management fees
• Repairs & maintenance
• Vacancy cost - this is when your property doesn’t have a tenant in place
• Valuations - I've written an article about why Registered valuations are required here. 
• Set up costs - solicitor, bank, accountant
• Interest on mortgage 

Once you’ve worked out or found out rough estimates on what the expenses are when purchasing your investment property, you can then work out the Net Rental Yield. 

By understanding the Net Rental Yield, you will get a better understanding of your numbers and make a more informed decision on whether buying this property is worth your money. No one wants to buy a dud, and a dud happens because they don’t do their numbers! 

How to calculate Net Rental Yield?

Below is the formula:

As an example, let’s assume:

• $750,000 is the property value (Purchase price or estimated market value)
• $33,800 is the annual rental income ($650 per week in rent)
• $5,000 is the total annual expenses 

Plugging in those numbers, the Net Rental Yield is:

The Net Rental Yield in the above example is 3.84%. 

Why is Net Rental Yield important?

The importance of Net Rental Yield is critical as it’ll determine if you are going to be cashflow positive, meaning after all the expenses you won’t have to top up with your money to maintain the property. Every week after, you’ll make money and have the first taste of passive income from your rental property!

With this number, you can judge if it is a good return on investment. 

What is a high Net Rental Yield?

Again, similar to what is a high Gross Rental Yield income, it is subjective as each person is in a different financial position. 

Following the same logic, where we compare the 1 year home loan fixed rate which is 2.49% as of October 2020, and also the term deposit rate for 1 year is 1.20%. 

Using the above example, if the net yield is 3.84% vs 2.49% or 1.20%, then depending on your risk profile, you can decide on what is a better return on investment. 

What is the difference between Net Rental Yield and Gross Rental Yield for a property?

The key difference between Gross and Net Rental Yield is the expense component in the Net Rental Yield formula. 

Gross Rental Yield is a faster calculation on the fly when looking at a property. However, to  analyse the property further, you will need to look at the Net Yield number. 

Capital gain vs Gross Rental Yield 

The long heated debate of which is better: capital gains or aim for high rental yield? 

Capital gains is the amount that your property value appreciates over the long term, at which point you can decide to sell up and take profit (beware of bright line test, best to speak to a tax accountant on this) or you could continue to leverage off it and obtain another rental property. 

The dream is to have both, a property where the return delivers huge capital gains and massive rental return with little to no maintenance! 

This is a balancing act and as mentioned before, it depends on what stage of life you’re in. Typically, for people who are in the early years of their life, who also have the ability to work and continue to generate an income, then going for a higher capital gains growth may be more appetising than switching to a lower capital gains property but a strong rental income to create more passive income. 

Or in some cases, I’ve seen property investors only go for pure Net Rental Yields, where the cashflow covers the majority of the cost over the life of the 20-30 year home loan. So the question to ask yourself is: what type of investor do you want to be?

Summary 

How to calculate Gross Rental Yield? Well there you have it. Hopefully you got value out of this blog post and if you’ve got any questions, feel free to drop a comment below! 

It is critical that you understand your numbers when investing in property and not go down the path of buying through emotions as it can be a costly mistake! You want to make sure your hard earned money is providing you with a return in the most effective way possible. 

If you want help in making a more informed financial decision when buying your first investment property or next investment property, then you can contact me on will@simplyfinance.co.nz or book in a call with me below.