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Understanding Yields

Mark Withers explains how a yield is calculated and why understanding yield is a key foundation of succeeding in property.

By: Mark Withers

1 March 2020

Understanding the mathematics of rental yields is probably the most important fundamental driver of financial success in property investment, bar none.

But yield calculations can be confusing and counter intuitive. Why does a yield fall when the property’s value is rising? These are the basics:

A property’s gross yield is the annual rent divided by the property’s value, expressed as a percentage.

So if a property rents for $500 a week and is worth $600 000 the yield is: (500 x 52)/$600,000 x 100/1 $26,000/600000 x 100/1 = 4.3%

So, if the property’s value goes up, let’s say to $800,000 but the rent stays the same, the yield has fallen. $26,000/800000 x 100/1 = 3.25%

The difference between gross yield and net yield is simply whether you have chosen to deduct the costs of rates, insurance and maintenance from the rental income. If you want to rip-rose tinted glasses off when making yield calculations, deduct these costs and use net yield and it will be more accurate.

‘I challenge my clients to always review their yields and to do so not based on what they paid for the property, but for what it’s now worth’

A key goal for property investors is to achieve a positive yield. This occurs when the yield exceeds the mortgage interest rate. This determines whether the property is positively or negatively geared.

You can use the same yield formula to work out the offer you need to make for a property for it to be positively geared. For example, if your interest rate is 4% and the property will rent for $600 per week, your offer is calculated like this:

Annual rent/desired yield. So, (600 x 52)/4% = $780,000 So if you pay no more than $780,000 the rent will be level pegging with your interest cost (if you borrow all the money).

Assess Your Investments

I challenge my clients to always review their yields and to do so not based on what they paid for the property, but for what it’s now worth.

Then ask yourself, would I buy it again at that price to achieve that yield? Take this for example. We have a property that cost us $600,000 that was renting for $500 per week at acquisition, (yielding 4.3%). We were happy with this because the property “washed its face” by covering its interest cost.

It’s now worth $800,000 but the rent is only $520. So its yield has now fallen to 3.4% which is less than the interest rate we are paying on our debt. If we now sell it and pay off debt we are increasing our profitability because the interest we save is $34,400 when our rent was only $27,040.

Would you sell? These are the questions you can pose when you calculate yields. Remember, the numbers never lie. ■

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