When buying an investment property, buyers need to understand the market and consider their strategy wisely before buying. Generally, investors focus on a high yield or capital growth when selecting an investment property – but is it possible to get both?
The difference between the two is often timing. If your strategy is to hold the property for 5-10 years, you’re likely to expect some capital growth. And securing a good rental yield also depends on timing – buying at a good price whilst rental interest levels are strong.
Finding a property that provides both is the Holy Grail!
Investment properties with a strong rental yield
When looking to buy an investment property, you’ll need to calculate both the gross yield and net yield to assess if the property is suitable for you. Gross yield is the figure most real estate agents discuss when selling a property, because it’s much higher than the net figure. Gross yield doesn’t take into account any of the ongoing or property costs. The difference between gross and net yields can make a big difference to how profitable your property is.
How to calculate a rental yield
To work out the gross rental yield, you need the annual rental income and the property purchase price.
Annual rental income = weekly rent x 52 OR monthly rent x 12
Property price = could be purchase or market value, depending on whether you are looking at the current performance, or future prediction.
Once you’ve worked out the 2 figures above, the calculation is relatively simple:
Gross rental yield = (Annual rental income / Property price) x 100
For example, a property that was purchased for $390,000 and returns a weekly rent of $500 would have a current rental yield of 6.66%. ($26,000 / $390,000) x 100 = 6.66%
Sounds good, right? But what about factoring in all the other costs of the property?
To accurately calculate the net yield, you will also need to research and/or estimate all of the costs and expenses associated with a property, such as purchasing and transaction costs, ongoing fees and expenses as well as vacancy costs.
Property purchase costs
- Mortgage costs (package fees, valuation fees etc)
- Building and pest inspections
- Strata reports
- Stamp duty
- Legal fees
Add up all of the property costs to get a total property cost figure.
Ongoing property expenses
- Mortgage interest repayments
- Repair and maintenance
- Strata levies
- Council rates
- Property management and advertising fees
- Loss of rent (e.g. during vacancy periods)
Add up all of the expenses throughout the year to get your total annual expenses figure.
Once you have all of the required figures, you can use this formula to work out the net rental yield:
Net rental yield = [(Annual rental income – Annual expenses) / Total property cost] x 100
Using the property in the previous example, where the purchase cost was $390,000 and the weekly rent was $500, if this property’s overall cost of purchase was $440,000 and the annual expenses are $5,000 (let’s pretend there is no mortgage on the property) then its current net rental yield would be 5%. This is significantly lower than its gross rental yield of 6.66% and may greatly affect your assessment of its value.
[($26,000 - $5,000) / $440,000] x 100 = 4.77%
Mortgage repayments and interest rates can change your yield from positive to negative
One of the reasons why investors love interest-only mortgage repayments is because the ongoing costs are lower than paying principal and interest (P&I) repayments.
For example, on a property purchased for $390,000 using a 10% deposit, leaves a loan balance of $351,000. Let’s calculate the interest rate at 3.89% to compare annual mortgage repayments;
Interest-only repayments $13,644 pa
P&I repayments $19,836 pa
Let’s add those figures to the $5,000 annual expenses we had calculated above put those more realistic figures into the yield calculator;
Interest-only repayments: [($26,000 – ($13,644 + $5,000)) / $440,000] x 100 = 1.67% net yield
P&I repayments: [($26,000 – ($19,836 + $5,000)) / $440,000] x 100 = 0.26% net yield
Both of these scenarios show a positively geared property, however, these calculations are based on 100% occupancy rate, so if you have a few weeks when the property is empty, you’ll need to put your own money in to cover the costs of keeping the property.
If the mortgage interest rate goes up by 1% to a rate of 4.89% those figures start to look my dire.
Interest-only: [($26,000 – ($17,160 + $5,000)) / $440,000] x 100 = 0.87% net yield
P&I repayments: [($26,000 – ($22,320 + $5,000)) / $440,000] x 100 = -0.30% net yield (negatively geared)
A mortgage broker is your investment property financial guru
Your investment property returns can change dramatically with a low interest rate, and an experienced mortgage broker is the best way to secure an investment property home loan. Mint Equity has access to over 40 lenders with 1,000’s of products to suit your investment property strategy.
Finding the next property growth hotspot can be tricky, but if your strategy is to hold the property or flip it, you should do your research before buying.
- Always consider the following before buying an investment property
- Suburb infrastructure, transportation and employment options
- Demographic of the suburb (owners or renters)
- Future plans for the suburb/region
- Existing property or brand new and the tax benefits
- Buyer interest levels should you need to sell quickly
- Rental return
- Has the growth already occurred? Are you too late?
- What will happen if the employment opportunities decline? (ie mining towns)
- Strata fees, are they too expensive and devalue your property when it comes time to sell
- Size of the property – some banks won’t lend on properties smaller than 50sqm which will reduce your buyer numbers
- Mixed residential and commercial use properties are classified as commercial and attracted more difficult lending policies and higher interest rates, which will reduce buyer numbers
- Holiday let and managed properties are harder to borrow money for, so this may reduce your buyer numbers.
Good financial advice is key to success
Investment properties have so many variables that contribute to their success or failure. Always speak with your accountant, financial planner and mortgage broker before buying.