For anyone who is considering purchasing an investment property, you will surely be interested in what return the property will give you – in other words, its yield.
Yield refers to the measurement of a future income on an investment. Before considering a property and adding it to a shortlist, most investors work out the yield on the property first.
Investment terms explained
Property investment is can be puzzling at the best of times, but without an understanding of the terms involved, it becomes nigh-on impossible. First, you need to get your head around what yield and return are. These are the terms most frequently used to explain a property’s investment potential, and so understanding them is central to investment success.
- Real estate yield
A real estate yield is a measurement of future income on an investment. It is commonly calculated annually as a percentage, based on the asset’s cost or market value. It has nothing to do with capital gain.
- Gross rental yield
A gross rental yield is the income on an investment prior to expenses being deducted. For property, these expenditures can be quite considerable, so there can be a vast variance amid gross and net yield.
- Real estate net yield
A real estate net yield is the income on an investment after expenses have been subtracted. The costs and expenses will likely include purchasing and transactions costs, such as stamp duty, legal fees, building and pest inspections, loan start-up fees, advertising, and rent lost due to vacancy.
There might also be repairs and maintenance outlays, management costs, insurance, rates and charges. Most of the time, you won’t know the exact amount of these costs and will have to estimate them.
- Return or total return yield
A return is the gain or loss made on an investment, over a specified period. It includes capital gains and is either expressed nominally, in dollars, or as a percentage derivative from the ratio of profit to investment.
Unlike the property yield, the return is focused on the properties past performance, rather than its future earning potential.
What is the difference between yield and return?
As explained above, a yield is only based on rental income, whereas a return includes capital gains.
Both are generally used in the sales pitch, but be sure to clarify the time periods associated with the statistics the agents provide before determining whether the property’s a good investment.
Remember, too, that one is reflective (return) and the other looks at the future (yield).
What does a ‘hard’ or ‘soft’ yield mean?
A soft yield means a yield is increasing and hard yield is when the yield is falling or reducing. The difference between both depends on what’s happening in the market.
Demand for property drives property prices up, and this can affect the yield of your investment property.
The more prices go up, the lower your rental income as a percentage of the property value becomes.
When you hear people talking about yields hardening, they mean that the yield is falling or reducing, as a result of property prices increasing; softening yields, meanwhile, means the yield is increasing.
As always, it is best to seek professional advice.