Rental yield is the annual net income that a property generates divided by the purchase price of the property. Rental yield can be expressed on a gross or a net basis. To calculate gross rental yield, investors subtract all property-related expenses (except for the annual mortgage expense) from property-related revenue. For net rental yield, the annual mortgage expense is also subtracted from property-related revenue. Rental yield is extremely easy to calculate once you estimate the income-generating potential of a piece of property.
Determine the monthly rent that your property can generate by looking at rents in similar buildings in the same geographical area. You should try to find buildings that are as similar to your building as possible, both in terms of age, amenities and location. Multiply the monthly rent by 12 to get annual gross rent revenue. For example, if your building has 10 units that will rent for £650 each, your annual gross rent revenue equals 10 x £650 x 12 = £78,000.
Estimate the likely vacancy rate of your building. It is generally not realistic to assume that 100% of your building will be rented at all times. Again, you can look at the vacancy rates of comparable buildings in the same geographic area. If the anticipated vacancy rate in your 10 unit building is 5%, the net annual rental revenue of the building will equal £78,000 x (1 – 5%) = £74,100.
Calculate the annual operating expenses associated with maintaining the building. Suppose that your 10 unit building will have insurance expense of £65 per month, taxes of £130 per month, and general maintenance expenses of £260 per month. The annual operating expenses of the building will equal ($100 + £130 + £260) x 12 = £5,460.
Calculate the annual mortgage expense for the property. Assume you buy the 10 unit building for £650,000 and suppose you use an £520,000 30-year mortgage with a fixed interest rate of 6%. You can calculate the annual mortgage expense easily by using Excel. Enter the following formula to calculate the annual mortgage expense: =PMT(6%,30,800000). The resulting annual mortgage expense is £37,777.
Compute net rental yield by dividing the building’s net income by the purchase price. The net income is equal to net rental revenue minus operating costs minus mortgage expenses. In this example, the net rental yield equals ($114,000 - £5,460 - £37,777) / £650,000 = 4.7%.
You can use rental yields as a way of comparing the attractiveness of different investment properties. Potential properties with higher rental yields are more attractive investment opportunities and are more reasonably priced given their income-generating potential.
Calculating the potential net income of a property depends upon assumptions regarding rent, vacancy rates and operating expenses. Hence, you may want to do a sensitivity analysis in which you look at the rental yield for a property at several different levels of revenue and expenses.