When buying your own home, you need to be good at negotiating with your partner over issues such as whether an outdoor pizza oven is a must-have or a nice-to-have. When looking for a suitable investment property, you need to be able to calculate the yield. Yield is the income you receive in rent, ideally giving you a positive cash return. The projected yield is treated as income by the bank when assessing your mortgage application.
Doing the maths can feel a bit intimidating when you’re new to the investment game but don’t worry, there’s a quick and easy trick that we use to calculate yield on any property we’re looking at.
To calculate the yield you only need:
You then divide the yearly rental income by the purchase price.
As an example, a $600,000 property might receive $500 per week rent.
$500 * 52 weeks is $26,000
$26,000 / $600,000 is 0.043 (or 4.3% return).
So this property has a 4.3% (gross) return based on rental income to value alone.
A 4.3% return won’t (currently) cover principal and interest payments or additional expenses like insurance and rates. But that doesn’t mean it’s necessarily a bad investment, as interest rates are expected to eventually come down, and capital gains can be made. What this calculation allows you to do is see how one property compares to another and estimate any shortfall in income that you may need to fund.
Let’s say that a 5% yield is a decent baseline for yield on a property. What is a quick calculation to get a 5% return? This is satisfyingly easy. For any property you are looking to purchase, knock the last 3 numbers off, and you have the approximate weekly rent required to get to around 5% yield. A $750,000 property needs a $750 per week rent. A $400,000 property needs a $400 per week rent.
Whether or not a 5% yield is reasonable depends on the local market. Average yields vary from place to place. The good thing about investment properties is you’re not limited to buying in the area you live in. Low yields in Auckland? Look at investing in the West Coast.
If our handy 5% calculation isn’t going to work for the market you’re buying in, the good news is you carry a
super computer smartphone in your pocket that allows you to do the proper yield calculation of yearly rental income divided by purchase price.
Currently, banks calculate the affordability of an investment property by scaling the projected yield to 65-88%. This is to reflect that there may be periods where the property isn’t tenanted, as well as costs such as rates, taxes, insurance and maintenance.
Example: Take a property with an expected rental income of $50,000. The bank could calculate the income based on 65% of that, making the “usable” income $32,500.
For more details on how the bank decides whether or not to approve a mortgage application for an investment property, see our article Can I buy an investment property? Or better yet, contact one of our mortgage advisers to get advice specific to you.
It’s not always easy to get started. What do you need to know?
We’ve put together the most important things to know when you’re looking at buying your next Investment Property and we are giving it away for free.
Mortgage Lab’s mission is to be the digital town square for financial decision-makers to gain knowledge about their current and future mortgage. Follow us on Facebook and LinkedIn or subscribe to our newsletter to be notified of our latest articles.
We all enjoy saving a bit of money, especially if you’re looking to buy your first home or if you’ve just got your first mortgage. There are all sorts of…
At least once a month, we try to bring you an unusual outside-the-box method to save money. Recently we’ve introduced you to Pocketsmith.com and shown you how cleaning your heat…
In today’s world, having a strong credit report is essential for achieving financial success. Your credit report not only determines your eligibility for loans and credit cards, but it also…