Being a landlord entails more than just the act of collecting rents. A landlord is, in fact, much like a businessman, and like most business, you want to ensure that your property is paying for itself. In a property investor term, that would mean having an excellent rental yield.
But what is an ideal rental yield? Even if the property is paying back for itself, how long does it take to pay back the entire sum of money invested in bringing it into economic existence? To figure this out, here is a rental yield computation as a guideline to determine your profitability.
What is rental yield?
It is calculated by taking your annual rental income generated by a particular investment property and dividing it by the total value invested in that property. Multiply this by 100, and you will get the percentage of the rental yield.
Why is rental yield important?
Rental yield works similarly like the return of investment ratio computation. As an investor, it is paramount that you know how much income your assets are generating to the amount of money you put in to bring into effect that income-generating asset.
If the rental you gain is only able to pay off for the maintenance cost incurred to keep that investment property running, then you are essentially breaking even, which means not making a profit or a loss. Conversely, if the rental gained is unable to cover up for the maintenance cost, then you are making a loss. Simply put, you could have used the money elsewhere in a more productive manner.
Computation
The computation of your rental yield can be broken down into gross rental yield and net rental yield.
Case study:
Assuming that your rental income per month is RM3,000
Then total annual rental income is: RM3,000 X 12 = RM36,000
Total maintenance cost is RM4,500
Purchase price of property inclusive of all related cost = RM500,000
Gross rental yield
Formula: (Total rental income per annum/purchase price of the property, inclusive of all related cost) X 100
(RM36,000/RM500,000) X 100 = 7.2%
On the other hand, the net rental income computation includes the number of expenses you incur to maintain the property.
Net Rental Yield
Formula: (Total rental income per annum - total maintenance cost/purchase price of the property, inclusive of all related cost) X 100
(RM36,000 - RM4,500/RM500,000) X 100 = 6.3%
Interpretation
The general rule of thumb states that the higher the rental yield achieved, the better. Depending on the location, area and type of property, the average rental yield may differ. In Malaysia, a rental yield of around 5% is considered decent. Based on the example above, the net rental yield of 6.3% suggests that the property is performing above the average.
Rental yield as a guideline
A prudent property investor manages his portfolio at the onset. That means you assess the property’s worth as an income-generating asset before buying it. Questions you need to ask include how much is the estimated rental income you can get per month?
You can derive your estimated rental rate easily by checking out the average rents of properties in the neighbourhood. Besides, rental yield also allows you to know if the rent you are charging is reasonable, or if it is time to review your rates.
It is normal for property investors to choose a property with good discounts, but it is more important to procure a property that is capable of paying back for itself every month. The benefits will soon outweigh the discount you previously received unless that discount is substantial. Combine discounts, high capital appreciation and rental yield, and you have in your hands, a stellar property for investment.
The journey of being a landlord is a wonderful lifetime of education
But of course, rental yield is only part of the determining factor for a real estate investor. For those interested in buying a property, whether, for own stay or investment purposes, there are other variables, both intrinsic and extrinsic, that need to be considered. Check them out at Factors That Affect The Value Of Your Property (Part 3)
Need tips on managing your rental property? Head over to Landlord’s Guide To Renting Out
