Property rental returns are an important metric to use to understand how a property is going to perform and what the cash flow will be like.
Is it going to deliver you passive income or cost you money each and every month? I am going to look at rental returns in more details in this episode.
Two Different Metrics Are Commonly Used
Property rental returns are important metrics that are used to understand how a property might perform. There are generally two different metrics that are used. There is gross rental yield and then there is net rental yield. Let’s look at those two and see how you can calculate each of them.
Gross Rental Yield
Working out gross rental yield only requires a very simple calculation. All you do is you take the weekly rent of the property and you times that by 52 (because there are 52 weeks in a year).
You then divide that figure by the purchase price of the property and that is going to give you the gross rental yield of a property.
If you are interested in positive cash flow properties then I do recommend trying to get around the 7% gross rental yield mark and higher than 7% is obviously better because it means you’ve got more rental income coming in compared to the purchase price of the property.
Almost every property I list inside On Property Plus is over 7% and I think the highest property that I ever listed was somewhere around 14% gross rental yield mark which is quite significant.
For help in calculating gross rental yield try this gross rental yield calculator.
Net Rental Yield
The other one that I want to look at is net rental yield. Net rental yield is calculated a bit differently and is a bit more complicated.
What you do with net rental yield is that you take that weekly rent times up by 52 again but then you take away all your expenses that you are going to incur in that year with the exclusion of your mortgage which we don’t look at in this instance. This includes things like insurance, rental maintenance, council rates, all that sort of stuff then gets taken away from the rent.
Then what you want to do is to divide that remaining figure by the purchase price combined with other costs that go into buying that property. This means you are adding your stamp duty, solicitor fees etc. You are adding these costs onto the purchase price.
So a net yield is always going to be smaller than a gross yield because you are taking money away from that annual rent and you are adding costs to the purchase price and so that’s going to give you a smaller percentage.
For help in calculating net rental yield try this net rental yield example calculation.
Property rental returns are important to know because the lower percentage return the higher the chance of the property being negatively geared. The lower the percentage return the more negatively geared it’s likely to be.
It also works in the opposite direction. The higher the rental return of the property the higher your chance for a positive cash flow situation.
As I said earlier on property rental returns of 7% to 8% tend to generate a positive cash flow situation in most circumstances. With interest rates so low at the moment at around 5% it is quite easy to achieve a positive cash flow situation on 8% or 9% or 7% .
Once you go below 6% or even 5% property rental returns become hard to generate a positive cash flow. Now the situation changes in the future and interest rates go up back to 7% or 8%. Well we are probably going to need a higher rental yield on our property in order to generate a positive cash flow.
Property Rental Income Isn’t Everything
Measuring a property’s rental returns isn’t everything because you also need to look at vacancy rates which when you’re looking at the yield you don’t take into account. If the vacancy rate of an area is extremely high well that makes the chances of your property going unrented for a long period of time high as well.
If the vacancy rates are low well the chances are that your property is going to be rented most of the year. It is very important that you look at vacancy rates as well and you don’t just look at the rental yield of the property.
Median Rental Yield Is Often A Useless Statistic
The last thing I want to say is that I have personally found median rental yield to not be an extremely useful statistics. The problem I found with median yield is that it’s not actually taking an average.
It is looking at the median for the prices of houses that have sold and then median for prices of houses that have been rented. But in a lot of situations your higher value homes are included in the prices of the properties but they aren’t often rented out so they don’t come into the rental aspect.
The figure is diluted in a lot of circumstances. I wouldn’t take a median rental as a true indication of what the area can generate for you.
I have seen median rental yields of 7% percent in areas where you can find properties with rental yield of upwards of 10% so it is something that you can look at to compare different areas but it’s not something that I would take too seriously.
So as you can see property rental returns are an important thing to look at when purchasing a property especially if you’re going after positive cash flow property because the lower the property rental return the lower the chance of that property generating you a positive cash flow.
If you want help finding positive cash flow properties go to On Property Plus because we list new positive cash flow properties every single week.