When you’re looking for an investment property, you are often either looking for capital growth or 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.
You’re going to need the following bits of information:
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 would cover most principal and interest payments (currently) but probably won’t cover additional expenses like insurance and rates. Each individual property requires a different amount of income to get positive cash results. What we’re looking for is a quick calculation to see how one property compares to another.
Let's say that 5% yield is a decent baseline for yield on a property. If we're looking for yield, anything below that is probably not worth investigating any further. What is a quick calculation to get 5% return?
Well, very approximately:
In the example above, the house was worth $600,000. If the rent had been $600 per week, then:
$600 * 52 weeks is $31,200
$32,000 / $600,000 is 0.052 (or 5.2% 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.
Currently banks calculate affordability of an investment property by scaling the projected yield to 65-75%. 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 detail 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 brokers to get advice specific to you.
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