The best possible investment outcome for any property investor is a combination of decent house price growth coupled with rising income from your tenants. But how important is the rental yield component and how can you improve the return from your investment property?
The level of rental return you can expect from an investment property is determined by several factors, including location and the type of property, as well as overall economic conditions.
If you pay a high price for a house in a popular suburb, you would hope that rental demand is high enough in the area to offset your higher costs of ownership.
This is crucial to the success of a rental income strategy.
Many people measure their returns using gross rental yield*, which is a percentage figure calculated by dividing the annual income earned on the property by its sale price or market value.
Using the current market value can be helpful because if a property rapidly increases in price but the asking rent does not, then the annual return or yield will fall.
In cases where you already own the property, however, you'd normally use the price you paid for it to make your calculation.
How's the property looking?
The condition of a property is also very important with regard to rental yield, because even in a high demand area, you’re not always guaranteed to have tenants. As a landlord, you can’t afford to let properties get scruffy if you want high occupancies and good yields.
Investing in a smart renovation can also improve your rental income, making it much easier to hold the property for the long term.
What should your yield be?
There's no hard and fast rule to this. According to CoreLogic, the highest-yielding metropolitan suburbs last year ranged between 5-7% for houses and 5-8% for units, typically in outer suburbs where properties generally cost less to buy.
Consider looking at rental yield to determine the market value of an investment property, as opposed to 'fair value' assessments made by comparing them with similar properties. If its gross rental yield potential is likely to be below, say, 4%, there's a chance it might be overvalued for investment purposes.
Conversely, if the gross yield is over 5.5% – and the rent is sustainable over the longer term – the investment property may be undervalued.
Units vs houses
In general, more compact housing such as units tend to offer higher rental returns than detached houses because the initial investment (i.e. the property's purchase price) is lower.
This can especially be the case in inner-city suburbs that, in the bigger cities at least, are likely to be in higher demand. A large two-bedroom unit in inner Sydney, for example, may command the same rent as a two-bedroom terrace in the same suburb but cost several thousand dollars less to buy, thereby increasing the yield.
* Gross rental yield does not consider all ongoing costs associated with property investment such as repairs and maintenance, strata levies and rates. Net rental yield includes these costs and can generally provide a better indication of the financial viability of investing in a property.