One of the first things you need to consider before purchasing an investment property is what your return on investment is going to be, or in other terms your yield.
What is yield?
Your yield is the measure of the future income of your investment and is worked out as a percentage based on a property’s cost, annual income and running costs. A property’s yield does not take into account capital growth.
You can quickly work out the gross yield of a property using the following formula:
Gross yield = annual rental income (weekly rental x 52) / property value x 100.
For a more accurate estimate of yield, i.e. one that takes into account expenses such as management fees and maintenance costs, it’s best to calculate a property’s net yield.
Net yield = annual rental income (weekly rental x 52) – expenses / property value x 100.
Net yield is generally more useful when doing your sums on a property, however it’s worth keeping in mind that it’s very difficult to accurately assess all expenses a property may have.
Yield vs. capital gains
One of the age-old property investment questions is whether to favour high yields or strong capital growth. Ideally a property would have both, however often investors need to decide which is more important to them.
Strangely enough, often a higher percentage return on investment is obtained from the lessor money spent. Higher long term capital gain opportunities however are more commonly from properties that show a lessor percentage return on investment, requiring a greater weekly / monthly contribution from the investor to hold on to it.
It is possible to have a property with high capital gain percentage and rental yields, but it is very rare.
It is up to each individual to work out what may work for them. A lot of people think that capital gains are king, however if a property is costly to hold onto it can place an investor under a lot of undue financial stress.
A higher yield can help an investor pay down their loan faster and can be useful in that it helps an investment property essentially pay for itself.
So which is the better investment? There is no accurate answer. Each investor needs to weigh up their objectives and how much risk they are willing to take on.
If you need any help we are certainly happy to discuss in the hope that we can assist you in determining what may be best for you.