What it means
Property investors want a simple way to compare a flat in one city with a house in another. Gross rental yield does this by dividing a year of rent by the price of the property.
A higher figure means more rental income for each dollar invested. The measure is popular because the two inputs are easy to find.
The rent comes from listings or the lease and the price from the purchase agreement or a valuation. No accounts, inspection reports or tax calculations are needed, so an agent can quote it in seconds.
Its weakness is the same simplicity. Gross yield ignores everything the owner pays, such as maintenance, insurance, management fees, property taxes, periods when the property is empty and interest on any loan.
Two properties with the same gross yield can have very different returns once these costs are counted. For that reason, professionals also use net rental yield, which deducts running costs from the rent before dividing by the price.
The gap between gross and net can be wide, particularly for older buildings that need frequent repairs or properties with high service charges. A sensible investor looks at gross yield to screen options and net yield to decide.
Investors also compare the yield with the cost of borrowing. If a property earns a gross yield of 5% but the mortgage costs 6%, the rent alone will not cover the interest, and the investor must be counting on the price rising.
This is a common trap in markets where prices are high relative to rents. The nuance is that yield is not the same as total return.
A property can have a low yield and still produce strong overall returns if its value rises steadily, and a high yield can sit on a property in a declining area where the value falls.
In practice
Real-world examples
Example 1
A buyer comparing two flats finds one priced at $300,000 renting for $1,500 a month and another at $500,000 renting for $2,200. The yields are 6% and 5.28%, so the cheaper flat looks better on income before costs are considered.
Example 2
A small business owner considers buying her office rather than renting it. The building would cost $900,000 and could be let for $63,000 a year, giving a gross yield of 7%, which she compares with the interest on her loan and with her business's usual returns.
Example 3
A property fund manager screens 40 listings for a new portfolio. She sets a gross yield minimum of 6% to shortlist buildings, then examines running costs in detail for the ones that pass.
Think of it
Think of gross rental yield as the top speed printed on a car brochure. It tells you what is theoretically possible under ideal conditions, but it does not tell you about fuel consumption, traffic jams, or maintenance costs.
Formula
Calculation
Gross rental yield = annual rental income / property price x 100
Suppose an investor buys an apartment for $400,000 and rents it for $2,000 a month. Annual rent is 2,000 x 12 = $24,000. Gross rental yield = 24,000 / 400,000 = 0.06, or 6%. If annual costs of $7,200 for fees, insurance, repairs and taxes are deducted, net income is 24,000 - 7,200 = $16,800 and the net yield is 16,800 / 400,000 = 4.2%.Case study
Seen in the real world
Greystone Residential is an illustrative, fictional landlord that bought two blocks of flats. Block A had a gross yield of 8.5% and block B had 6.0%, and the first impression was that Block A was far better.
When the finance team added service charges, repairs and the periods when flats were empty, block A's net yield fell to 3.9% because it was an older building in a lower-demand area. Block B, in a popular area with new fittings, kept a net yield of 4.8%.
The illustrative lesson is that gross yield is a screening tool. The company changed its policy so that no purchase could be approved on gross yield alone, and every proposal had to show the net figure as well.
Watch out
Common mistakes
- Treating gross yield as the return an investor actually keeps, when costs such as repairs, tax and empty periods can remove a large part of it.
- Comparing gross yield with a mortgage rate to decide whether a property pays for itself, without allowing for running costs and vacancies.
- Using the asking price instead of the full purchase cost, which leaves out fees, stamp duty and other charges that raise the amount invested.
Questions
People also ask
What is the difference between gross and net rental yield?
Gross yield divides rent by price, while net yield first subtracts running costs from the rent, so net is always lower.
Is a high gross yield always better?
Not necessarily, because a high figure can reflect higher risk, such as a weak area, a poor building or unreliable tenants.
How do I calculate yield on a property I already own?
Use the current market value rather than the original price if you want to know what the property earns on what it is worth today.