Investors often chase rental yield when growing their property portfolios—a strategy that follows the widespread belief that “cash flow is king”. Find out how it can actually influence the overall growth of your asset.
Basically, rental yield is the cash generated by your asset annually as a percentage of its value.
The two main types of rental yield are gross rental yield and net rental yield.
Gross rental yield is your annual rent income divided by your property’s value, while the net rental yield takes into account the total property expenses including stamp duty, legal fees, loan fees, pest and building inspections, repairs and maintenance, management fees, insurance costs and other rates and charges.
For example: The purchase price for your property is $700,000, the rent price you set is $400 per week, and you spend $5,000 each year to hold the said asset.
Your gross rental yield formula will be ($400 x 52) = $20,800 / $700,000 = 2.97%
Meanwhile, your net rental yield formula will be ($400 x 52) = $20,800 - $5,000 = $15,800 / $700,000 = 2.25%
The calculation of the rental yield usually comes in handy even before purchasing a property because, by determining the said value, you can compare your desired property with other comparable assets in terms of potential returns.
If you have yet to determine the actual price of the property, you can calculate using median price of properties in the suburbs of your choice to aid your decision-making.
Some investors also take into account the market yield and debt yield in their investment purchase decision-making. Market yield is the total rent income over the asset’s current valuation, while debt yield is the total rent income against the size of the mortgage.
Experts advise against having rental yield as a sole consideration when investing in property, but a high rental yield can definitely improve your cash flow situation and may increase the value of your property over time.
In contrast with rental yield, capital growth is the measurement of how much your property’s value has appreciated from the date of purchase to the day you decide to sell it.
This means that, unlike the potential income projected by the rental yield which you can access immediately, you can only benefit from the capital growth profit when you sell your asset.
Aside from being dependent on the period of time you have owned the property, the value of capital growth is also influenced by market conditions, the property’s location, the type of property and the renovations done through the years, if any.
Investors are often divided in their opinions about whether to prioritise rental yield over capital growth or vice versa, but experts say that there is no one right answer for all.
Ultimately, choosing between which strategy to implement depends on your financial situation and your end goal.
Properties with good rental yield are best for investors looking to improve their cash flow.
Moreover, according to Right Property Group’s Steve Waters, a cash flow investment lowers risk and, therefore, makes your portfolio more sustainable.
“A high cash flow where all the income takes care of all the expenditure gives you serviceability, which gives you time in the market because you’re not at the mercy of high interest rate and market fluctuations,” he highlighted.
However, he said, the growth in dollar value may not be as attractive.
On the other hand, chasing capital growth can help you make big money if you invest in a sustainable market and hold your asset over a period of time.
Mr Waters explained: “If you’re holding $2 million in assets, an annual rise of 5 per cent in value translates into $100,000 in the first year which continues to compound as the property price cycle runs its course.”
But, unlike cash flow investments, capital growth investments are more exposed to external risks such as interest rate movements, unexpected personal crisis and vacancy rates since you don’t have an income buffer to take care of low-cash flow periods.
Ultimately, according to Mr Waters, the ideal scenario is being able to marry the two and sustain balance in your portfolio for the long-term.
If you’re looking to maximise the rental returns you get from your property, you may consider implementing one or more of these strategies:
This information has been sourced from the Commonwealth Bank of Australia and the Smart Property Investment website.