No investor, no matter how experienced, can see into the future. Unforeseen business expenses can seriously affect your profit margin, so you just need to hope they won’t be too costly.
Nevertheless, you can calculate with reasonable accuracy the property investment yield of each piece of real estate you look at to determine how much the profits you’ll generate will exceed the expenses you expect to incur.
What is investment yield?
In real estate investment terms, yield refers to the earnings you generate through rents over a specific period of time. You express it as a percentage of the market value of your investment property or how much you invested in it.
There are three different kinds of yield:
Gross yield: The total amount of rental income your property generates — ignoring expenses, insurance, taxes, and debts — expressed as a percentage of your investment.
Net yield: The total amount of rental income your property generates minus expenses, insurance, and taxes, expressed as a percentage of your investment. Net yield does not consider any debt you have on the property, such as your mortgage and the mortgage payments you make.
Cash-on-cash rental yield: The total amount of rental income your property generates minus expenses, insurance, taxes, debts, and any cash you invested to buy the property, expressed as a percentage of your investment.
How do you calculate property investment yield?
To help you understand the investment yield formula, we’ll use a simplified example.
Let’s say you bought an investment property for $250,000. You plan to rent it out for 1 percent of its market value, or $2,500 per month. You assume it’ll be occupied all year. Your insurance costs $1,000 per year; your taxes are $1,300 per year. You have a maintenance budget of $1,000 and have to pay a 5 percent rent management fee.
Gross yield: Your rental income for the year would be $30,000 with a monthly rental income of $2,500. Your gross yield is your gross annual return divided by your total investment: $30,000 divided by $250,000 equals 12 percent.
Net yield: Your property’s annual expenses equal $4,800. Your net yield is your gross annual return minus your expenses, divided by your total investment: $30,000 minus $4,800 and then divided by $250,000 equals 10.1 percent.
Cash-on-cash rental yield: Now let’s say you paid $75,000 (30 percent) down and took out a mortgage of $175,000. Using this mortgage calculator, we can assume your monthly payments would be $1,099. Your cash-on-cash rental yield is the difference between your gross annual return and your expenses, including mortgage payments ($17,988), divided by your cash down payment: $30,000 minus $17,988 equals $12,012, divided by $75,000: That equals a cash-on cash rental yield of 16 percent.
Pro tip! If you’d like an easy, more detailed calculation of projected profits on a real estate investment you’re looking at, use this rental property calculator.
What is good yield in property?
The general consensus among real estate investors is that a property investment yield of 8 percent or more is considered good, and yields of 5 percent or less are considered bad.
The bottom line
Knowing property investment yield will help you make smart buying decisions and avoid the properties you’d sink more money into than generate a reasonable return from. To learn more about investing in real estate, check out this guide.