Rental yield is an investor’s return from rental income on a property. This yield can be calculated in a couple of ways, and you may want to do both, as they each have their place in your assessment of a property’s suitability to your investment objectives. We’ll look at Net Rental Yield and Cash-on-Cash Yield. We will self-manage the property, so there will be no property management cost included in either calculation. Another assumption for both calculations is a 5% vacancy rate. Finally, we’ve purchased the property for $150,000.
Net Rental Yield:
This method takes your costs of operation, maintenance, taxes and other outlays into account, but not the mortgage payments. Here are some numbers:
- $1200 per month for rent, or $14,400/year
- After vacancy estimate, rent income is $13,680
- Repairs are budgeted for $700/year
- Insurance and taxes are $1800/year
- $13,680 - $700 - $1800 = $11,180 net rental income
- $11,180 / $150,000 is a net rental yield on purchase of 7%
Now we want to do the calculation not from a gross cost perspective, but from a cash outlay approach. We want to take all our cash invested in the property and see what the return is from rental income on that money. This includes our mortgage payments.
- We’ll use the same expense and rent income from above
- Mortgage is 6.5% interest, and we paid 20% down
- $120,000 financed, with PITI payment of $908/month
- $908 x 12 = $10,896 cash into the property annually
- $13,680 - $10,896 = $2784 net after outlays
- $2784 / $30,000 down payment is an 9% yield on cash invested
Using these calculations, an investor can compare two real estate investments, but also compare other investment returns to a potential rental property investment. However, if you’re comparing it to buying stocks or bonds, remember the other advantages to real estate:
- Appreciation in value over time
- Tax advantages include depreciation and interest deductions
- Expenses can be deducted as well
- Via 1031 Exchange, property can be exchanged with income taxes deferred
There are so many reasons why we invest in real estate, and these calculations help us to measure our returns and reinforce our commitment.