Rental yield compares the cash generated by a property as a percentage of the property price or market value. Of the many financial metrics that real estate investors use to analyze property, rental yield is a quick and easy tool to help identify properties that offer the most profit potential.
- Rental yield can be calculated on both a gross and net basis.
- Gross rental yield compares gross rental income to property value or asking price.
- Net rental yield compares net operating income to property value or asking price.
- A property can have a high gross rental yield but a less than desirable net rental yield due to high operating expenses.
- Real estate investors averse to risk may choose to purchase newer homes in better neighborhoods with a lower net yield.
- Opportunistic investors may opt for properties with higher gross and net yields in exchange for accepting more potential risk.
Why rental yield matters
Rental yield in real estate allows investors to quickly and easily tell if a property will be potentially profitable.
Real estate investors also use rental yield to help predict whether or not the fair market value of a property will increase, because higher rental yields may indicate that tenants see more value in a home and are willing to pay a higher rent.
Generally speaking, the higher the rental yield, the better the investment may be, because the property is generating more revenue and income on both a gross and net basis.
Gross vs. net rental yield
There are two types of yield in real estate – gross yield and net yield – and each rental yield calculation offers a different perspective of how a property is currently performing financially, and how it might perform.
Gross rental yield
Gross rental yield in real estate is expressed as a percentage and measures the total amount of annual rental income compared to the price of the property.
For example, if a single-family rental home with a market value of $175,000 generates a gross annual rent of $14,000 per year, the gross rental yield is 8.0% ($14,000 annual gross rental income / $175,000 property value).
Note that gross rental yield does not reflect how much profit (or loss) the property is generating, only the amount of gross rental income compared to the property price. Gross yield excludes operating expenses such as the property management fee, repairs and maintenance, and taxes and insurance that are part of owning and operating any rental property.
Although gross yield in real estate does not factor expenses into the calculation, gross rental yield can be a good way of narrowing down potential investments before spending time analyzing each property in detail.
Net rental yield
Net rental yield in real estate is also expressed as a percentage, and measures the amount of net operating income compared to the price of the property.
To illustrate, we’ll use the same single-family home with a market value of $175,000 and a gross annual rental income of $14,000. Annual expenses run about $5,000 (or about 36% of the gross rental income), leaving a net operating income (NOI) of $9,000.
The net rental yield on the home is 5.2%, and is calculated by dividing the NOI of $9,000 by the property value of $175,000.
Note that net operating income includes normal operating expenses, but not costs such as debt service and mortgage interest, capital expenses, or depreciation. That means the net rental yield is the same thing as the cap rate of a property, because both formulas use NOI and property price or market value to determine the annual return on an investment.
How investors use rental yield
While gross rental yield does have its limitations, there are a couple of reasons why an investor might calculate the gross yield of an investment property:
- Compare potential investments
An investor may set a minimum acceptable gross rental yield when analyzing various investments in different real estate markets.
By dividing the actual or estimated rental gross rental income by the asking price or market value of the property, an investor can quickly calculate the gross rental yield of the property to see if it makes the cut.
- Establish a monthly rent
Calculating gross rental yield is also an easy way to ballpark what the monthly rent on a vacant property should be, before creating a detailed rent comparables report.
For example, assume a vacant home has an asking price of $135,000. If the gross rental yield from similar homes occupied by renters is 8%, an investor can determine what the monthly rent on the unoccupied home should be by rearranging the gross rental yield formula:
- Gross rental yield = Annual gross rent / Property value
- Annual gross rent = Property value x Gross rental yield
- $135,000 property value x 8% gross rental yield = $12,150 annual gross rent or $1,012 monthly rent
After using the gross rental yield calculation to narrow down the list of potential properties to buy, an investor can calculate the net rental yield of each home to gain a better understanding of the profit potential of each property.
A closer look at rental yield
Experienced real estate investors understand that it’s possible for a property with a high gross rental yield to have an unattractive net rental yield. That’s because net rental yield factors in operating costs such as property management, repairs and maintenance, and insurance and property taxes.
For instance, imagine an investor is analyzing two different rental homes to invest in with asking prices of $150,000 in two different states.
Both properties are currently occupied by good tenants and generate a gross rental yield of 9%, for an annual gross rental income of $13,500 per year. The homes are professionally managed by a great local property management company, so the yearly cost for repairs and maintenance is about the same.
However, after taking a closer look at the income statements of each property, the investor learns that the property taxes on one home are significantly greater than the other home.
Because of high property taxes, one home has an annual NOI that is $1,500 more than a comparable home in a higher-tax state:
|Home||Gross rent||Price||Gross yield||Op Exp||NOI||Net yield|
Although both homes have the same gross rental yield, the net rental yield calculation shows that one property may be much more profitable than the other.
Is there such a thing as a good rental yield?
While it would be nice to give a definitive answer to this question, the truth is that a good rental yield for one investor could be not so good or even terrible for another investor. That’s because every investor has a different level of acceptable risk and reward.
However, there’s a saying in the real estate business that there is a property for every buyer and a buyer for every property.
The Roofstock Marketplace is a good place to find homes with different gross and net yields to help meet the goals of nearly every real estate investor.
For example, a newer home in a 5-star neighborhood listed for sale on Roofstock might offer a gross rental yield of 6% and a net rental yield (or cap rate) of 3%. On the other hand, an older home in a 2-star neighborhood offers a gross yield of about 12% and a net yield (cap rate) of 7%.
A more risk-averse investor may opt for a newer, more expensive home in a top-rated neighborhood and school district. Although the home price is higher, newer homes generally mean lower maintenance and repair costs.
For an investor willing to accept more potential risk in exchange for a higher possible reward, a home located in an average neighborhood might be the better choice. The purchase price of the property is lower, and both the gross rental yield and net rental yield are about double compared to newer homes in the higher-rated neighborhoods.
How to increase rental yield
Real estate investors use a variety of strategies to increase both gross rental yield and net rental yield. Gross yield can often be increased by raising the rent or generating additional revenue streams, while investors may be able to increase net rental yield by reducing operating expenses:
Tips to increase gross yield
- Allow pets to increase the pool of potential renters and generate additional pet rent.
- Thoroughly screen tenants by reviewing rent to income ratio and running complete background, credit check, and rent history reports.
- Monitor conditions in the local marketplace to help ensure rents are always at market.
Tips to increase net yield
- Hire a great local property manager who understands the market and has an established network of cost-effective vendors.
- Perform proactive maintenance, such as replacing air filters and seasonal service of the heating and cooling systems to help catch minor inexpensive problems before they become more costly.
- Use a free rental property asset management system like Stessa to automate income and expense tracking and help maximize profits.
Gross rental yield is a good screening tool to choose properties that generate higher amounts of rental income compared to the property value. Net rental yield is a calculation used to measure the potential return from a property once operating expenses have been factored in. Real estate investors calculate rental yield to help identify properties with the most profit potential and to identify opportunities to increase overall returns.
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