Without doubt, real estate will be among that first things that come to mind when searching for an investment. Whether in the form of passive income through renting out your property, be it a condominium or a house, or a possible more profitable resale in the future, real estate will give you the best bang for your buck.

For first-time investors in real estate, prime location and affordability are the factors that are immediately taken into consideration. However, for seasoned investors and property advisors, it is rental yield that helps evaluate the desirability of an investment.

Rental yield determines the rental income that a property will generate annually as a percentage of the asset’s total value. This makes it easier for investors to determine how long it will take to recover an investment depending on their investment goals or the profit you will make in the long run. The rental yield may be one of the indicators of the value of an asset in the future. This can also be a great way to anticipate the risks involved when considering a property.

This makes it a major factor to look into before a purchase. Aside from your return on investment, your rental yield will:

Calculate the value of your investment

There are two types of yield to consider: gross and net yield.

The former is easier to calculate, which is simply (rent x 52 weeks) = total ÷ property value x 100 = rental yield. The net yield is more difficult to determine. This takes into consideration other variables such as the rental demand on your location, insurance, interest rates, periods of vacancy, and repairs and maintenance; just to name a few.

There will always be other factors, some unforeseen, to also consider in the long run; such as mortgage interest, management fees, depreciation, taxes, and so forth should you intend to also sell your property in the future. 

Help identify profitability 

A proper understanding of the net yield of your property gives you a grasp on the profitability of your investment. This also means giving your due diligence in proper research of available and updated data of the median rent and prices of the properties in the area you are eyeing.

There will be some instances in which there will be available published gross yields while conducting research on investments. However, it would also help to evaluate other fees that are involved. For example, a piece of property situated in a building which demands higher management fees might prove to be a less desirable option than a unit which might offer lower yields, but also cheaper expenses.

It is important to remember that a property should not be purchased based on its reduced price or discount, but based on its ability to be able to pay for itself over time and make a profit at the same time.

See the bigger picture

A higher yield usually means a better investment, but not necessarily a profitable one. A high yield should never be the main determining factor for capital growth. A good rental yield is usually pegged at 8% or higher. A lower yield might not generate the cash flow needed to cover other expenses like mortgage payments or other unforeseen expenses.

Below market value properties can seem attractive to novice investors, but if the yield is not proportionate to what is needed to both cover expenses and generate profit, then this would just simply render a stagnant investment. To go lower than the standard 8% should be a calculated risk you are willing to take.

Your rental yield should be able to cover the maintenance of your property, and most importantly, an emergency fund. No property is immune to expensive unforeseen incidents such as sudden plumbing problems, roofing repairs, to name a few.

Set your goals

Another thing to look into is to consider the short-term and long-term goals. A strategy must always be in place tailored to the value of the property. An investment with a higher yield calculation may look attractive, but it may not be in a location that is more likely to depreciate in value, or would be more difficult to sell in the future.

The location should be in a place where the returns will make sense, such as a property where a mass  metro train station will be built. The demand on the property will be higher and will be more attractive to renters who might be willing to pay more for accessibility. 

In the end, the rental yield is only supposed to help you align your investment goals. Investors must always try to find a balance across all variables. Capital growth, location, and demand must be taken into consideration when developing an investment strategy. The bottom line is still what role your asset plays in your portfolio.