The two main reasons for investing in rental property are to generate extra income in the short term, and to realise a return on your original investment in the long term. The first is fairly easy, provided your rental income exceeds your rental property expenses. But a return on the original investment (ROI) will take a long time to achieve through rents alone, according to information gathered by Baxton Property Management in Hobart. However the inherent value of the property is almost always the winning card when it comes to your investment paying off.
When considering ROI, your reason for investing in the property is important. Was it purely an investment, or a way to to secure a home at current prices you can retire to later? If it’s the first, both avenues are important. In the second, your rental yield needs to cover your costs and give you an extra income, but the real ROI is in being able to avoid higher property prices when you retire.
The goals of an extra income, and a return on the original investment have to be looked at separately. Fortunately in many cases both targets can be reached, or at least used to balance each other out, if necessary.
Calculating your extra income
Extra income is calculated in terms of rental yield from many properties at lower rents, or fewer properties at higher rentals. The yield is calculated either as Gross yield (before expenses) or Nett yield (after expenses).
Gross Yield: Your gross rental yield is calculated using your annual rental income as a percentage of the value of the property. The value can be either what you paid for it, or its current market value.
As an example, let’s say you bought a rental property for $390 000, and you earn $500 in rent per week ($26 000). The current market value is $600 000. The calculation is simple: Gross Rental Yield = [annual rent received, divided by the value of property] x 100.
If you use the original purchase price, the yield is 6.67%. If the current market value is used, the yield is lower, at 4.33%. However, although the rental yield is lower percentage-wise because of the increased value, your extra income hasn’t dropped in dollars. Nor has it affected its relationship to the initial investment.
Nett Yield: The nett yield takes a more realistic approach by taking into account the rental property’s expenses every month, as well as what was spent in acquiring it, like stamp duty and legal costs. The equation looks something like this: Nett rental yield = [(annual rent – annual expenses)/total property cost] x 100. Using the same scenario we sketched earlier the rental yield drops to 5%.
Return on investment
Obviously, you will have to think long-term if you are looking for a return on investment based solely on the rental yield. On its own, rental yield provides a short-term return every month if you have money left after expenses. But if rely on it alone, for many years you will be paying off the original cost of the investment, which leaves little chance for any substantial ROI.
It will take even longer if you keep adjusting the target by consistently pushing the value up to the current market value in your calculations. That shifts the goalposts based on a potential value that already theoretically includes a ROI on the original price if it’s greater than what you paid. However, if you do sell your property at the current market value, the situation changes. You will immediately see a very real return on investment if that value is higher than what you still owe.
Selling the property
In our example the property’s theoretical market value has risen by $210 000, which is over 53% return on the original price. But that only applies if you sell it for that price. If you do sell, and depending on how much time has intervened, that’s a pretty good ROI, even without adding in the rental yield you got in the interim.
Should you sell for less than you owe, the picture is not so good. You would be in a negative equity situation, with no return on investment other than the rental yield. And chances are you will have actually lost money.
Rental property investment is a tricky business and its success or failure depends on what your ultimate goal is in investing in that property. ROI is something every investor looks for. One of the key factors in generating a return is to minimise costs, and up occupancy rates. For this you need professional property managers, like Baxton Property Management in Hobart. For more info visit the Baxton website.
Written and syndicated by
– Baxton Media.
#1 – Australia’s Property Management Specialists