Calculating gross yield using market value
Gross rental yield = Annual rental income (weekly rental income x 52) / market value x 100
I often seen gross yield calculations made using the current rent and original purchase price. These sorts of calculations can be misleading as they don’t take into account the time value of money or the change in value of the underlying asset. After all, a dollar today is not the same as a dollar yesterday. If you want to draw comparisons between historic versus current rental return, you’re better off making separate calculations.
It’s also important to remember that a high gross rental yield is not the be all and end all. A property may have a high gross rental yield but the rental return may be low when expenses are accounted for.
For these reasons, I think net yield is a better measure than gross yield when assessing returns.
Calculating net yield
Net yield is particularly useful when determining your financial capability as it will give you a truer indication of whether you can afford to invest, what your financial position will be and whether your investment will be self-sustaining.
To calculate net yield, you’ll need to know or estimate:
Annual expenses: managing agent fees, vacancy costs (lost rent and advertising), repairs and maintenance, insurance(s), strata levies (if applicable), rates and charges, etc.
Total property costs: purchase price plus transaction costs (e.g. stamp duty, legal fees, pest and building inspections, loan set up fees, etc.) and the cost of any renovations or furnishings needed before tenants can move in.
Here’s how to calculate net yield:
Net yield = (Annual rental income – Annual expenses) / (Total property costs) x 100
You’ll note that I haven’t included mortgage interest or tax in the above example. This is because these vary depending on the circumstances of the owner and aren’t directly related to the property itself. They should of course be included in any return on investment calculations.
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The time value of money (TVM) is the concept that money available at the present time is worth more than the identical sum in the future due to its potential earning capacity. This core principle of finance holds that, provided money can earn interest, any amount of money is worth more the sooner it is received.