What does rental yield mean and how does it affect capital growth?

What does rental yield mean and how does it affect capital growth?

Kathryn Lee - 23 Jul, 2019

Buying a house in a nice suburb with a verandah out the back – it’s the great Australian dream! But increasingly, young Australians are ditching the domestic dream, buying property not to live in but rather, as an investment.

But is buying property always a good investment? After all, just like the stock market, the property scene can be fickle and prone to fluctuation. Luckily, there’s a metric to help property investors predict whether a property is going to be a lucrative investment down the track – rental yield.

So, what does rental yield mean and how does it affect capital growth? Here, we give you the lowdown.

What is rental yield?

Simply put, rental yield refers to the return you get on the investment of a property. It’s essentially a way to measure the gap between how much you spent purchasing the property and the income you generate from renting it out. It also happens to be one of the most important metrics for determining the value and profitability of a property!

Why is rental yield important?

Rental yield is important for a variety of reasons. Firstly, it’s helpful for when you’re looking at at a few different properties or areas to purchase in. At a glance, it helps you compare which property is going to give you the best rental return. So, if you’re looking at 10 similar-sized properties in different areas, it could be the deciding factor in which one to purchase. It also helps you predict your rental return and therefore, forecast your cash flow – which is particularly important if you want to generate passive income. Finally, it’s useful for when you need to review the rent or your investment portfolio.

How is rental yield calculated?

Generally speaking, your rental yield is calculated by taking the rental income you generate as a percentage of your property’s value. However, there are two different ways real estate agent talk about rental yield – net rental yield and gross rental yield.

How to calculate gross rental yield

This is the most commonly used calculation, as it tends to be quick and easy. However, it can be inaccurate as it doesn’t take property expenses into account. To determine your gross rental yield, you’ll first need your annual rental income. This can be found by taking your weekly rental income and multiply it by 52. To get the gross rental yield, simply divide this number by the property value (either the market value or purchase price), then multiply this number by 100.

Gross rental yield = Annual rental income (weekly rental income x 52) / property value x 100

How to calculate net rental yield

This is the more accurate option, but it’s not as common since it can be difficult to acquire all the necessary information. To work out your net rental yield, start with your annual rental income as per above. From this, you will then need to factor out the cost of annual expenses such as property upkeep, strata levies, home and contents insurance and vacancy costs. Once you have taken the property expenses from the annual rental income, simply divide this figure by property’s total cost (the purchase price or market value plus purchasing costs such as stamp duty, conveyancing, lender fees). Multiply this number by 100.

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

What is a good rental yield in Australia?

The answer to what is a ‘good’ return on investment property depends on where you’re looking to purchase. In metropolitan areas (particularly capital cities) a typical gross rental yield would be around 3-5%. That’s compared to 5% + in regional areas. So, in short, whether or not 4.5% is a good rental yield depends entirely on where you are are!

What are the best cities to invest in real estate?

Looking at rental yields is a great way to compare which Australian city is best to buy an investment property. Data from CoreLogic shows Hobart currently has the best average gross rental yields of any Australian capital city, for both houses and units. Here, the average house costs $398,522 with a rental yield of 5.5% and units cost an average of $305,592, with a 5.8% yield. The next best performing city is Darwin (4.8%), followed by Adelaide (4.6%), Brisbane (4.5%), Canberra (4.4%) and Perth (4.1%).

What is the average rental yield in Melbourne and Sydney?

So, what about the larger cities like Melbourne and Sydney, where properties are significantly more expensive? CoreLogic data shows that Melbourne’s gross rental yield is 2.7%, while Sydney’s is 2.9%.

What do higher yields mean?

A higher rental yield means there’s a lower gap between what you purchased the property for and the rental return. Increasing your rental yield means you have more positive cashflow which can mean more passive income in your pocket.

How do you increase rental yield?

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The good news is, your property’s yield isn’t fixed – there are things you can do to improve your rental return once you’ve bought it. Firstly, you’re going to want to make sure you’re charging the right amount of rent. Be sure to compare it to other similar properties on the market. If you do find you’re shortchanging yourself, you can consider raising the price – although be sure to give the tenant plenty of notice and be prepared for the possibility of losing them.

Some other ways you can boost your rental yield include making your property pet-friendly, allowing shorter-term tenancy agreements or adding something like a laundry or off-street parking. You may also want to review your property management and home loan to ensure you’re getting the best possible deals and services. Finding a better option may put more money in your back pocket and improve your cash flow.

Another way to increase your rental yield is by making some improvements to your rental property.

What inexpensive improvements can I make to my property to help increase my cash flow?

Making your property more desirable doesn’t always have to be expensive. Here are a few simple projects you can take on yourself.

  • Flooring: To rejuvenate tired floorboards, simply hire a floor sander and buy some varnish. You can also replace worn carpet. Such projects can cost around $5,000 but will add as much as $20,000 in value.
  • Kitchen: Replacing a whole kitchen is expensive. Instead, look at changing cupboard doors or painting over existing doors to give the area a facelift.
  • Painting: The interior and exterior of a home can dramatically change with a lick of paint. Sanding, then applying a fresh coat of paint adds more than $20,000 to a neglected home.
  • Landscaping: The entrance to a property and its street appeal are big drawcards so having a poorly maintained garden – or no garden at all – can be major letdowns. Landscaping doesn’t have to be expensive; using recycled pavers you can add up to $15,000 to the value of your home. Adding a shade sail, mulch or turf are other great ideas.

Is real estate rental a good investment?

Real estate is thought of as a good investment as the value generally increases over time and it can generate ongoing passive income. However, the benefits of buying an investment property depend largely on where, when and what you buy and the rental return you receive as a result – as well how much you’ll get if you eventually sell it.

How do you find a good rental investment?

Comparing rental yields is an effective way to make sure you’re looking at a worthy investment opportunity. However, it’s not the be-all to end all. Some other things to look at include:

  • Growth markets: Look at areas where high growth is predicted and there is potential for capital gains
  • Desirable features: Check for properties that have appealing features such as proximity to a beach, public transport, beach, and cafes or a walk-in wardrobe or a lock-up garage
  • Wide appeal: Properties that appeal to a wide range of people – such as couples, families and singles – are generally going to be easier to rent out
  • Local changes: Be sure to inquire about any proposed changes in the area such as zoning restrictions or new developments, as these can affect the value of your property
  • Low vacancy rates: If a neighbourhood has high vacancy rates, it may indicate a less desirable area which can make it more difficult to rent out your property
  • Maintenance: While pools and extensive landscaping may make a property more desirable, they can be expensive to maintain. When shopping for an investment property, sometimes it is wise to avoid these features.
  • Property types: Larger properties typically demand higher rents, however, smaller units tend to be less expensive to maintain than a house. This can be worthwhile considering before buying an investment.

Are apartments good investments?

Apartments can make an excellent investment property – provided they hit the right balance between desirability and scarcity. Location tends to be key when it comes to apartments, so be sure to do your research into the area to ensure there’s plenty of growth potential.

How do you claim rental income?

So, you’ve chosen a great property and you’ve got plenty of rental return coming in. How do you actually deal with this income for tax purposes? According to the Australian Taxation Office (ATO), rental money you receive from renting out a part or all of your property is considered to be assessable taxable income. This means it’s taxed at your marginal tax rate and has to be declared in your income tax return. By understanding how rental yield works, you have a useful metric you can use to weigh up your investment options. This helps you ensure that the property you’re buying is going to contribute to your long-term financial goals.

Words by Emma Norris

Thinking of buying an investment property? eChoice’s experienced mortgage brokers can help you compare hundreds of home loan options and find the right option to suit your needs. Just remember this is a guide only, and before making a decision we suggest you seek legal advice.

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