Calculating the basic returns on an investment property is probably one of the quickest and most common methods you hear about and used by industry professionals when advertising ‘For Sale’. But what does it mean?
A rental property will generally earn two types of return: - Rental Yield (income) - Capital Growth (increase in property value)
Both combined make up your total return.
Calculating Rental Yield To work out the rental yield, take the weekly rent and multiply it by 52 to get your annual income. Then divide the annual income by the value of the property and multiply the result by 100 to get a percentage return on investment.
Example: If your property is worth $ 450,000 and you receive $450 in rent per week the calculation would be -
Annual income - $ 450 x 52 = $ 23,400
Percentage ROI - $ 23,400 divided by $450,000 x 100 = 5.2% gross yield
Don’t forget this figure is Gross and all other holding costs need to be deducted (insurance, property management, maintenance, etc).
Calculating Capital Growth Capital growth is the percentage increase in the property’s value over time.
Example: If a property is worth $ 450,000 at the start of the year, then rises in value to $ 472,500 by the end of the year, the calculation would be -
Value increase - $ 472,500 - $450,000 = $ 22,500
Capital Growth - $ 22,500 divided by $450,000 x 100 = 5% growth
There are no guarantees that your property will increase in value year on year, it may vary both up and down. This activity is all part of a normal property cycle which is why choosing the right property is as important as choosing the right location, when to buy, keeping it over what time period and knowing when to sell later.
Obviously in an ideal world you want a property with high rental yield and strong capital growth prospects, however these types of properties are often elusive unless you are prepared to put in some time and effort.
Thinking outside of the square and considering all options when reviewing a potential property is normally where the true value can be found.
Understanding how to calculate the returns on a property lets you see how your current or potential investment is performing or could perform relative to other investments.
If you would like to go through your investment property figures in more detail to work out if you have the ideal combination please contact us today.