Understanding return on investment
Investing in property isn't rocket science but does require a bit of homework. That’s where understanding potential returns on investments comes in.
It's every property investor's dream to own a property that has a high yield, will deliver a large capital gain, has a strong rental return and will require low maintenance. Here are some basics to help you understand returns and get you closer to your property dream.
Understanding capital gain
Capital gain is the profit you make when you sell an investment for more than you paid for it.
Some people buy investment properties to make a long-term profit - as prices rise over time. This strategy may be coupled with little or no profit in the short term, as expenses, such as mortgage repayments and insurance, also need to be taken into consideration.
Understanding rental yield
Yield comes from the rental money received from tenants. It's the rent a property could provide over a year, expressed as a percentage of its purchase price.
This is the income return on your investment before any expenses, outgoings or possible rental vacancies are taken into account. Gross yield also does not take interest rates into account.
Gross rental yield is commonly used when looking at returns, as it is simple to calculate and lets you easily compare properties with different values and rental returns.
This is the income return on your investment after any expenses or other outgoings, such as maintenance and insurance, are taken out. Net yield is sometimes referred to as ‘rate of return’.
Although the gross rental yield is a simple calculation, it’s important to remember that it doesn’t take other factors, such as expenses, interest rates or periods of vacancy, into account.
For example, a property may have a high rental yield but may also have high maintenance costs, which may make the rental return low when taken into consideration.
High yield for cheaper areas
It’s a general rule of thumb that yields are higher in cheaper areas. But the return always needs to be weighed up alongside other factors such as maintenance, tenants, expenses and capital gain.
Gross rental yield
To calculate, take the 'Annual rental income (Weekly rent x 52 weeks)' and divide by the 'Property value'. Then multiply this number by 100.
Example: Property value $600,000 and expected rent $500 a week.$26,000 ($500 x 52 weeks) (annual rental income)
÷ $600,000 (property value)
Yield = 4.33%
Net rental yield
To calculate, take the 'Annual rental income' and minus the 'Annual expenses or loss of rental income' from this. Then divide this number by the 'Property value' and multiply this number by 100.
Example: Property value $600,000, expected rent $500 a week and expenses/loss $5000.$26,000 ($500 x 52 weeks) (annual rental income)
- $5000 (annual expenses/loss)
÷ $600,000 (property value)
Yield = 3.5%
Expenses or loss of rental income can include:
- Purchasing and transaction costs (property purchase price, legal fees and building inspections, any start-up loan fees)
- Annual costs such as vacancy costs (loss of rent and advertising)
- Repairs and maintenance
- Property management fees