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What is Net Yield in real estate?
Net Yield is a metric that shows the current net income return on the value of an investment.
Why is Net Yield important?
Net yield is important because it allows an investor to compare a specific rental property to other available investments, whether they are other rental properties or stocks or bonds.
How to calculate Net Yield
Net Annual Rent ÷ Current Market Value (what you will have to pay for the property)
How to calculate Net Annual Rent
Gross Rent - Expenses
Net Annual Rent is the total rent revenue collected minus all expenses (see below). Current Market Value is the appraised or estimated value based on comparable properties (comps). Also referred to as Net Rental Yield, this metric helps rental property investors understand the expected performance of a rental property relative to other investments on a net income basis. This is a very useful metric because it takes into account cash flow that will be produced by the property, takes out expected expenses such as maintenance costs and interest expenses and divides it by the capital outlay you will have to make to acquire this property.
Expenses
- Mortgage principle, interest, taxes, insurance ("PITI"
- Landlord insurance
- Property management
- Maintenance
- Vacancy
- Uncollectible rent
Net Yield Formula
A more detailed formula for Net Yield:
(Gross Rent - Expenses) ÷ Current Market Value
Example of Net Yield
If you own a single family rental property worth $100,000 with $10,000 per year in gross rent (total rent) and $6,000 per year in expenses: your net yield is 4%. That's ($10,000 - $6,000) ÷ $100,000, which is $4,000 ÷ $100,000 or 4%.
Do rental property investors use Net Yield
Yes! It's an important metric that helps rental and real estate investors to compare their investment opportunities to one another, holding all other factors constant. Net Yield can't be used in vacuum and should only be used as part of a comprehensive and holistic analysis where other metrics are also used to paint the full picture of the investment opportunity that is being dissected.
What is the difference between Gross Yield and Net Yield
These are two different mathematical formulas that carry different implications for the analysis of the investment opportunity at hand. One big difference between Gross Yield and Net Yield is that Gross Yield doesn't take into account expenses. It's a much simpler formula that just looks at cash inflows and divides them by the capital invested. This is a faster, less precise metric that distorts the comparative value of investments. Two properties might look similarly attractive on Gross Yield basis, but once you factor in expenses (such as maintenance of an older property, or difference in mortgage expenses due to loans you were able to secure in different parts of county) and calculate the Net Yield, two investment opportunities might start to look vastly different.
How to use Net Yield as a tool to measure your investment?
Net Yield is a total return you receive while owning a property, while ignoring future changes to your assumptions (such as maintenance expenses and interest expenses). Larger Net Yield indicates that the owner will recoup their initial capital outlay faster between comparable investment opportunities. Quicker recoup period indicates a smaller degree of risk to the capital, since it will be recouped. However, there is an important consideration, Net Yield will look really good if the capital outlay is becoming smaller. Its important to understand while initial outlay of capital (the denominator) is smaller for the cashflow minus expenses that you are expecting to receive. Some good questions to answer are:
- Are property value falling? What is the trend for local real estate?
- Why am I able to charge these rents if property values are so low?
- Will I be able to continue to charge these rents?
- Will property value appreciate or depreciate over my holding period?
Once answering these questions in the context of Net Yield you will have a better grasp on the risk profile of the property. Thus, higher Net Yield is not always better because of trends that might impact property value and rent collectability in the future. Keep in mind, as a rental investors you are provided a depreciation shield in the form of depreciation charge that you can use on your taxes for 27.5 years. Many rental investors use this length of time as time horizon where they will hold their property. So its good idea to use this time length in estimating your holding period and estimating how it will affect your maintenance expenses.
What are draw backs of Net Yield?
The largest drawback of net yield is that it looks at a point in time and doesn't consider potential changes in its assumptions. For example, what if the rent you expect to receive, changes over time (grows or shrinks due to vacancies). Yes you can somewhat capture that through uncollectible rent expense but once again, its not a precise measurement. Other property expenses can also change over time, such as property management and maintenance expenses. In fact it's guaranteed that with age, the property will require more maintenance and maintenance expenses should grow into the future. To improve the Net Yield formula, a growth factor for expenses should be incorporated, but once again, this is an assumption that isn't precise and hard to accurately estimate between properties to increase the usefulness of the Net Yield formula as a tool for evaluating investment opportunities.
