What is Investment Yield?
Yield is how much you make annually from a real estate investment. Yield can take on many meanings in finance. It plays an important role in commercial real estate to assess the future income on a property. As a result, yield can transform a traditional homeowner into a real estate investor.
Yield is the income you earn from an investment property every year expressed as a percentage.
The formula to calculate yield is annual income divided by the property’s total cost or estimated current market value.
Net Yield vs. Gross Yield
Gross yield does not include the costs of maintaining your investment, such as home maintenance and repairs. It also does not consider any interest you may be paying on your property loan.
On the other hand, the net yield is your profit after you subtract your expenses. Therefore, net yield is typically less than your gross yield calculation.
How to Calculate the Rental Yield for Homeowners
Let’s say you rent a $300,000 property for $2,000 a month. So, your annual income is $2,000 x 12 months = $24,000.
Your annual income of $24,000, divided by a property cost of $300,000, gives you 0.08 or an 8 percent gross yield.
Your net rental yield gives you a better idea of how much you are really making from your investment. Here are your costs.
• Annual insurance cost: $1,200
• Annual taxes: $1,100
• Annual maintenance and repairs costs: $500
• Rental management fee: 5 percent
Your total annual expenses come out to $2,944. If you subtract your expenses from your annual income, you get a net profit of $21,056.
$21,056 divided by $300,000 gives you a net rental yield of approximately 7 percent.
This example does not include the interest rate you might have on your mortgage or the time that your home may be unoccupied or between tenants. Of course, these two rates vary from homeowner to homeowner and will lower your yield rate.
Unlevered Yield vs. Levered Yield
If we dive a bit deeper into the fundamental principles of real estate investing, we need to address how financing your property impacts your yield.
Unlevered yield follows the same principle as gross yield. It calculates the return on an investment, or income, out of the amount invested, but without including financing costs such as interest rates.
Let’s say you purchase a home for $450,000 and spend $100,000 to renovate the property. The total spent is $550,000. You hope to charge $36,000 per year in rent. Your unlevered yield would be 6.5 percent ($36,000 / $550,000).
Now let’s say you took out a loan for $300,000 and put down a cash down payment of $250,000. The principal and interest payments for the loan come out to about $16,728 per year. Therefore, the annual income drops from $36,000 to $19,272. The property’s levered yield would be 7.7 percent ($19,272 / $250,000).
In this example, levered yield showed that this real estate investor had a higher yield rate when financing part of the property with a mortgage. In other words, his money was working harder to yield a higher rate of return.
Why It Matters
As a real estate investor, it’s critical to evaluate whether or not your property is a good investment. Your yield rate, after you subtract your expenses and financing costs, can tell you if you should consider looking for a better rate of return elsewhere and whether you should use a loan to finance your real estate investment.