There are many reasons why people invest in real estate and they come with different investment strategies. Whether buying for potential capital growth or investing in real estate to fund one’s retirement account for future use, investment strategies vary depending on these goals. But should rental yields play a role in your investment strategy and does it make sense to base your strategy on current and potential rental yields?
What is rental yield?
For those new to the real estate investment game, rental yield is essentially a way to measure the income your property generates each year as a percentage of the total value of the property. In real estate, that return is rental income. When purchasing a rental property, you may be told either the current gross yield or the net yield. The gross yield is often what is quoted when a buyer asks for it.
A high yield often means the potential for good cash flow and therefore a better return. It can help with purchase loan approval, but rental yields can vary depending on the market. So while the price may be high at the time of purchase, there may be an oversupply of that particular type of property in a few years, for example, which could in turn affect your rental yield.
What can affect rental yields?
There are many factors that affect rental yields. It is important to note that the return at the time of purchase may not be the same one or five years later. So what are the main factors that cause a change in rental yield?
- Rental rate increases or decreases: Rents increase or decrease over time based on market demand. This may be based on employment, prices of similar properties, municipal tax costs, etc.
- Property Value: Since the rental yield is an overall percentage of the property value, the yield changes as the property value increases and decreases.
- Oversupply or undersupply: An oversupply or undersupply of properties in the market can affect the rental rate, which in turn affects the yield.
- Positive or Negative Properties: Positively oriented properties will generally have a better return, so if your expenses start to exceed your rental income, you may see your rental return decrease. These are just a few of the many things that can affect the rental yield of your real estate investment, and there are many other things to think about.
How important is the rental yield when buying?
While this is a number to consider before purchasing your next investment property, you can’t rely on this number alone. The gross rental yield is not an expense. The net rental yield may be a better indicator, but it only takes into account a small number of expenses. It often does not take into account mortgage payments and taxes.
If you are considering your investment strategy, you need to consider several factors: the location of the property, past rental and sales performance in the area, vacancy rates, purchase price, insurance costs, rate costs, etc. Making a decision based solely on rental yield may not be the wisest investment choice.