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If you are thinking of buying a property for investment purposes, what is a good gross yield?

I've been told you should take 3 zero's off the price of the property, so if a property is worth 400,000, it should be rented out at $400 per week.

That works out at a gross yield of about 5.2%.

That seems to be normal for my area right now, but is that good historically? Cause in stock terms, a 5.2% yield works out to be a price/earning ratio of about 19:1, which I think is fairly high and what you'd expect from high growth stocks.

And 5.2% is the gross yield, that's before taking into account things like maintenance costs, land taxes, rates etc.

8

I've never heard of rent quoted per week. Are you in the US?

In general, after the down payment, one would hope to take the rent, and be able to pay the mortgage, tax, insurance, and then have enough left each year to at least have a bit of emergency money for repairs. If one can start by actually pocketing more than this each year, that's ideal, but to start with a rental, and only make money "after taxes" is cutting it too close in my opinion. The 19 to 1 "P/E" appears too high, when I followed such things I recall 12 or under being the target. Of course rates were higher, and that number rises with very low rates.

In your example, a $320K mortgage at 4% is $1527/mo. $400/wk does not cut it.

  • in Australia, you generally pay per week. so 5% is low? Cause it's pretty much impossible to find something higher than that here. Generally, you'd buy a house and the rent may cover part of your mortgage payment, but not all of it. Most people buy houses cause they expect that when they sell, the prices will be higher. – Joe.E Jan 30 '12 at 2:35
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    @Joe.E From what I know (knowing a little about the ownership and renting markets in both the US and Australia) it completely depends on the area. In Australia, renting is much cheaper in relation to buying than in the US. – Nicole Feb 5 '12 at 18:42
  • @Joe.E Unless there is Vancover type hyperiflation where rent is just covering the mortgage interest, that doesn't seem to make sense. Why would someone make such an investment? Wouldn't people just put more money down to get positive cash flow? – Justin Dearing Oct 27 '14 at 21:45
  • "I recall 12 or under being my target" - The SP500 is currently 20.55 . You are expecting almost double the return of the stock market? – Superbest Apr 10 '15 at 23:59
  • If you read the question, the 19X is gross, not net profit. Since posting my answer, I bought a house with 3 apartments. The post renovation final cost was $180K, the gross rent is $30,300. A 'P/E' of 6. 12 was way too high. After expenses, it may settle to as high as 12, of course. The comparison to the market is not perfect, often misleading. – JTP - Apologise to Monica Apr 11 '15 at 0:43
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You will find Joe.E, that rents have increased considerably over the last 4 to 5 years in Australia. You can probably achieve rental yields of above 5% more than 20km from major Cities, however closer to cities you might get closer to 5% or under.

In Western Sydney, we have been able to achieve rental yields close to 7%. We bought mainly in 2007 and 2008 when no one was buying and we were getting properties for 15% to 20% below market rates. As we bought cheap and rents were on the increase we were able to achieve higher rental yields.

An example of one particular deal where we bought for $225K and rented for $300/wk giving us a yield of 6.9%. The rent is now $350/wk giving us a current yield of 8%, and with our interest rate at 6.3% and possibly heading down further, this property is positively geared and pays for itself plus provides us with some additional income.

All our properties are yielding between 7.5% to 8.5% and are all positively geared. The capital gains might not be as high as with properties closer to the city, but even if we stopped working we wouldn't have to sell as they all provide us income after paying all expenses on associated with the properties.

So in answer to your question I would be aiming for a property with a yield above 5% and preferably above 6%, as this will enable your property/ies to be positively geared at least after a couple of years if not straight away.

  • 2
    The right calculation of yield is not to divide by the price you paid, but by the current market price. Rents have gone up but some data says that sale prices have gone up even more, therefore yields have fallen. – poolie Feb 6 '12 at 4:13
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    @poolie, you work out the yield based on current rent and current price if you are looking to buy. If you have bought already what is the use of working out yeild based on current price. The aim is to work out your return based on the price you paid. If you base it on the current market price it only gives you an indication of what the property is currently yeilding compared to the general market, but will not give you an indication of your returns from the property. So it depends what information you are after, and I am after the retuns based on what I paid for it. – Victor Feb 6 '12 at 6:07
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    There might be someone who bought in the 50s and is getting a >100% "yield". But that is no help to the OP, who wants to know what price he ought to pay. – poolie Feb 6 '12 at 7:53
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    @poolie, that is what I said, that if you are looking to buy you work out the yield based on current rent and current price. My perspective was to gauge how the property is performing over time using the yeild based on current rent over the purchase price. If a property was bought in the 50s the mortgage would have been paid off and the property probably passed on to dependants, so these calculations would most likely be usless to the dependants. – Victor Feb 6 '12 at 8:50
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    @poolie - i think i agree with you. There's no point looking at your bought price, because that's a transaction in the past. Even if you bought previously, you should be comparing the current price and current rent to work out your yield, because if you sold the house, you'd be getting the current price. – Joe.E Feb 12 '12 at 1:29
3

A good quick filter to see if a property is worth looking at is if the total rent for the property for the year is equal to 10% of the price of the property. For example, if the property is valued at $400,000 then the rent collected should be $40,000 for the entire year. Which is $3,333.33 per month.

If the property does not bring in at least 10% per year then it is not likely all the payments can be covered on the property. It's more likely to be sinking money into it to keep it afloat.

You would be exactly right, as you have to figure in insurance, utilities, taxes, maintenance/repair, mortgage payments, (new roof, new furnace, etc), drywall, paint, etc.

Also as a good rule of thumb, expect a vacancy rate of at least 10% (or 1 month) per year as a precaution.

If you have money sitting around, look into Real Estate Investment Trusts. IIRC, the average dividend was north of 10% last year. That is all money that comes back to you. I'm not sure what the tax implications are in Australia, however in Canada dividends are taxed very favourably. No mortgage, property tax, tenants to find, or maintenance either.

  • RDL, the problem in Australia is that to achieve a yeild of 10%+ you would have to go to small country towns, where vacancy rates can be over 30%. Also, the likelyhood of the rent covering all costs is largely dependant on the interest rate at the time. If interest rates are 5% or less a yeild of 7%+ should cover most costs, hovever if interest rates are 9%+ then not even 10% yeild would cover all cost. So when interest rates are high you need to increase rents accordingly to help cover these costs. Thus, you may not get a yeild of 10% straight off but can work towards it over a few years. – Victor Jan 30 '12 at 23:53
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    @Victor, agreed, it is different everywhere. Another thing to consider is what is your time worth? If you acquire a property and are constantly putting money into it to keep it afloat, there is no guarantee that there will be a return on your investment down the road. By investing your money you will have much better luck and far less headaches. There is still risk but it's diversified versus having everything in one basket. Hope that helps. – RDL Jan 31 '12 at 0:47
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Historically that 'divide by 1000' rule of thumb is what many people in Australia have thought of as normal, and yes, it's about a 5.2% gross yield. Net of expenses, perhaps 3-4%, without allowing for interest.

If you're comparing this to shares, I think the right comparison is to the dividend yield, not to the overall PE. A dividend yield of about 3-5% is also about typical: if you look at the Vanguard Index Australian Shares Fund as a proxy for the ASX the yield last year was about 4%.

Obviously a 4% return is not very competitive with a term deposit. But with both shares and housing you can hope for some capital growth in addition to the income yield. If you get 4% rental yield plus 5% growth it is more attractive.

Is it "good" to buy at what people have historically thought was "normal"? Perhaps you are better off looking around, or sitting out, until you find a much better price than normal.

"Is 5% actually historically normal?" deserves a longer answer.

1

The rule of thumb I have always heard and what we rent our rental house at is 1% per month at the minimum (in the US). The rent has to cover the mortgage, the property taxes, the homeowners insurance, your income taxes (on the rent), the maintenance of the property and the times when the property is vacant. Even at 1% per month that doesn't leave a whole lot of profit compared to what you put in. I have no idea why anybody would buy a rental property in Australia if all they could get is 5% per year before expenses. They couldn't possibly be making money in that investment, not to mention the aggravations of getting late night phone calls because something broke in the rental house. No way I would make that investment.

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    The tax situation in Australia can actually make it beneficial to have a rental property that is losing money. read more – psatek Feb 8 '12 at 11:15
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    I read the negative gearing link and it was interesting. But I don't understand why it would be advantageous to (For example, lose $1000 in order to save $300) in taxes. – Dunk Feb 13 '12 at 22:46
  • @Dunk, totally agree, that is why I aim for positively geared properties. Negative gearing is aimed mainly at higher income earners on higher tax brackets looking to reduce their tax. The aim is to get tax benefits now and later reep the rewards of capital appreciation. 2 problems with it though, capital appreciation is not guaranteed and alot of lower income earners with lower tax brackets fall for the hype without actually knowing what they are really doing. – Victor Feb 17 '12 at 6:08
0

Our two rentals have yielded 8.5% over the past two years (averaged). That is net, after taxes, maintenance, management, vacancy, insurance, interest. I am only interested in cash flow - expenses / original investment. If you aren't achieving at least 4.5-5% net on your original investment you probably could invest elsewhere and earn a better return on a similar risk profile.

-1

I would just like to point out that the actual return should be compared to your down payment, not the property price. After all, you didn't pay $400K for that property, right? You probably paid only 20%, so you're collecting $20K/year on a $80K investment, which works out to 25%.

Even if you're only breaking even, your equity is still growing, thanks to your tenants. If you're also living in one of the units, then you're saving rent, which frees up cash flow. Your increased savings, combined with the contributions of your tenants will put you on a very fast track. In a few years you should have enough to buy a second property. :)

  • what about the $320k of interest you have to pay? At 7%, that works out to be more than 20k... and then there's the opportunity cost of the 80k you would've got had you just left it at the bank... – Joe.E Feb 15 '12 at 10:28
  • @Joe.E, Yes, at such a usurious rate it's not going to work. But you can do a lot better than 7% in today's market. As for the "opportunity" at the bank, which bank will give you even 10% annual interest? And even if they did, it would be taxed at a much higher rate that rental income. – alekop Feb 15 '12 at 19:36
  • what country are you basing this on? At the moment, you'd be doing well if you find anything under 7% in Australia. Interest rates do go up and down, but ur assertion of making 25% profit per year is absurd unless you pay zero interest – Joe.E Feb 15 '12 at 21:58
  • My bad, I was thinking of US rates. Also, I guess I should clarify that I'm talking about gross income. Subtract your expenses from that and you'll have your net income. This is much more accurate than rule-of-thumb guesses. – alekop Feb 15 '12 at 22:45

protected by Chris W. Rea Dec 2 '16 at 19:07

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