Let’s talk investment terms – rental yield and capital growth.

If you’re a first-time property investor or even just dabbling in the idea of investing, you’re probably feeling a little bamboozled by all the buzzwords. There’s a lot to learn, but to get you started here’s the first of the key terms you’ll need to understand – rental yield.

What exactly is rental yield?

Quite simply, it’s the amount of money you make on your investment – the gap between your overall cost and your rental income. It’s important to understand to give you an idea of your ongoing return on your investment and will help you review the cost of rent on the property too.

Looking into the long term, it’ll help you see if it’s the right rental property for your long-term goals – your money may be better spent elsewhere.

Calculating rental yield

This is the amount of rent you receive each year – the full amount without deducting any property expenses. It’s the annual rent as a percentage of the property’s purchase price.

 Here’s what you have to do:

1. Add up your total annual rent that you would charge a tenant
2. Divide your annual rent by the proposed purchase price of the property
3. Multiply that figure by 100 to get the percentage of your gross rental yield

Here’s an example of calculating gross rental yield.

Let’s say, you receive $50,000 each year in rent, and the property is going to cost you $500,000 to buy. Your gross rental yield is equal to $50,000 ÷ $500,000 X 100 = 10%.

Put simply, the annual rent ÷ the price of the property X 100.

Calculating net rental yield

 Calculating net rental yield takes into account all of your expenses. Here’s how you crunch the numbers:

1. Add up all the fees and expenses of owning the property 
2. Add up the annual rent you will receive from the property 
3. Subtract the total expenses from the annual rent 
4. Divide it by the value of the property
5. Multiply by 100

Examples of some of the expenses you might have from your property include:

• Repairs and maintenance
• Body corporate fees
• Council rates
• Water and sewerage charges
• Property management and advertising fees
• Landlord Insurance
• Depreciation

It’s important to note, interest on your loan is not calculated for your net rental yield – that relates to your financial situation, not to the cost the property generates.

An example of how to calculate net rental yield

Let’s say, you receive $50,000 each year in rent. You pay $10,000 each year in property-related expenses, and the property is purchased for $500,000.

Your net rental yield is equal to ($50,000 – $10,000) ÷ $500,000 X 100 = 8%

What is a good rental yield?

The answer to this really depends on where you’re buying and your particular gearing requirements. In metro areas, gross rental yields range from 3 – 5%, however regional can be 5% plus. Some of the top yielding suburbs in Australia have rental yields of 11%. See top 10 list below.

Top 100 rental yield suburbs Australia

• #1 BLACKWATER, QLD – 11.7% 
• #2 BROKEN HILL, NSW – 11.7%
• #3 WOREE, QLD – 10.8%
• #4 MANUNDA, QLD – 9.5%
• #5 KATANNING, WA – 9.1%
• #6 COBAR, NSW – 8.8%
• #7 BORDERTOWN, SA – 8.8%
• #8 BUNGALOW, QLD – 8.7%
• #9 MORANBAH, QLD – 8.7%
• #10 PORT AUGUSTA, SA – 8.4%

Sometimes you’re looking to maximise tax breaks too and in this case a good rental yield is not simply the highest yield but the one that allows you to benefit from negative gearing tax benefits.

There’s no one-size-fits-all good rental yield. The best buyers agents will discuss the rental yield requirements that are best for your unique situation in consultation with you.

Overall, chasing rental yield isn’t a strategy that works for everyone. High rental yield is good for investors that need positive cashflow. Lower rental yields are good for investors that need negative cashflow. But the other important thing to consider is the property’s capital growth.

What is capital growth?

Quite simply, it’s the increase in value of your property portfolio over time. It’s critical to consider this alongside your rental yield. While regional areas rental yield may be higher, metro properties in cities like Melbourne and Sydney have seen property values double in a short period of time.

Of course, there’s no guarantee your property will gain value over a given period, you can do your research to find places that are expected to boom – generally where there’s upcoming investment in infrastructure.

Pros of pursuing capital growth

If you do your research and find a growth location, you can make a huge amount of money in a shorter time frame. Most investors generally have to wait 10+ years to see growth. When you’re researching though, just be aware of so-called growth figures, which could be annualised 10-year growth figures.

As an example, let’s look at two suburbs. Suburb A has a 7% annualised growth rate, while suburb B has a 2% annualised growth rate. On the surface, A seems like a smart option, but when you consider which suburb has more room to grow, B could be a better option.

Cons of pursuing capital growth

First of all, you may need to outlay a significant amount of money to buy the property and then pay more upfront, if the property isn’t positively geared.

Why? Two key reasons.

Your rent is unlikely to cover your mortgage, particularly if the home loan is 90% or more of the value of the property.

These types of prime real estate properties often carry a big price tag and will cost you more in stamp duty and land tax.

Generally, they’re not the go-to for first time property investors.

Growth or rental yield, what will it be?

Like everything, it depends on your personal and financial circumstances. There’s pros and cons for both. Look at the facts and make the right decision for your financial now and financial future.