If you are aspiring to be a successful property investor, there are many things to keep in mind – from understanding the local sentiment to the desirability of the location. Many successful investors have their own curated system to analyse a potential real estate investment and most times, the property’s rental yield is synonymous with the suitability of the investment. When you know the potential yield of a rental property, you will be in a better position to understand if it is the right purchase for your investment portfolio, or whether if you should consider other opportunities.
Generally, rental yield is the percentage of rental income over the purchase price. It is a simple measurement to identify the yearly return an investor can gain from renting out his property. It is often used as a benchmark in identifying if the property can be rented out for good income.
What is rental yield?
Rental yield is essentially a mathematical calculation to help landlords understand how much money they can make by renting out their property investment in comparison to the overall cost of purchase.
For simple understanding, there are two forms of calculation to a property’s rental yield. Firstly, you have the gross rental yield, a quick and easy calculation of rental income/purchase price. On the other hand, you have a net rental yield that takes into consideration the total expenses related to the property.
Calculating gross rental yield
Gross rental yield is the rent income a rental property earns before taking into consideration any expenses made for the property. It is basically the annual rental income earned as a percentage of the property’s purchase price.
Step by step guide to calculating gross rental yield
- Sum up the total rental income earned from the rental property in January to December
- Divide the total rental income earned by the purchase price of the property (inclusive of all purchase related costs)
- Multiply the result from #2 by 100% to obtain a percentage
Example calculation for gross rental yield
- Property purchase price = $500,000
- Purchase related costs (stamp duties and legal fees) = $10,000
- Rental income every month from property = $2,000
- Total property purchase cost = $500,000 + $10,000 = $510,000
- Total rental income earned in 12 months = $2,000 x 12 = $24,000
- Rental yield for property = $24,000 ÷ $510,000 x 100% = 4.7%
For simple calculation, gross rental yield = annual rental income ÷ property purchase price inclusive of related cost x 100%
Calculating net rental yield
Net rental yield is the rental income a rental property earns after taking into consideration any expenses made for the property. The expenses considered in this calculation can be items such as maintenance and repair, insurance premium and management cost.
Example of expenses from the rental property
- Regular maintenance and repairs
- Quit rent and assessment fees
- Advertising fee and property agents’ commissions
- Housing insurance
- Amortized cost for furniture
Step by step guide to calculating net rental yield
- Sum up total rental income earned from the rental property in January to December
- Sum up total expenses made on the rental property in the same period
- Subtract the total expenses from the total rental income
- Divide the value in #3 by the purchase price of the property (inclusive of all purchase related costs)
- Multiply the result by 100% to obtain a percentage
Example calculation for net rental yield
- Property purchase price = $500,000
- Purchase related costs (stamp duties and legal fees) = $10,000
- Rental income every month from property = $2,000
- Expenses made on the property (for maintenance and etc.) = $1,500
- Total property purchase cost = $500,000 + $10,000 = $510,000
- Total rental income earned in 12 months = $2,000 x 12 = $24,000
- Total expenses in the same period = $1,500
- Rental yield for property = ($24,000 – $1,500) ÷ $510,000 x 100% = 4.4%
For simple calculation, net rental yield = (annual rental income – expenses made) ÷ property purchase price inclusive of related cost x 100%
In my opinion, the interest charged on the mortgage loan should not be included in the expenses’ calculation. Strictly from a business standpoint, you want to understand the financial health of the business without taking into consideration the leverage taken. To understand if the business is in the black, it is a simple comparison of your net rental yield to the interest rate charged by your financier.
What is a considerable rental yield?
There is no hard answer on what is a commendable rental yield for rental properties. Ideally, it will be good if the rent collected covers the maintenance expenses and the monthly mortgage instalment. With this understanding in mind, a considerable rental yield should be at least 1-2% higher than the mortgage interest rate.
On average, a 5% gross rental yield is considered to be a desirable rental return for most property investors.
How can I improve rental yield?
Typically, a good property should be located in a highly desired location with good nearby amenities and accessibility. The closer the property is to business hubs and offices, the higher the expected rental a landlord can demand for their rental properties.
However, this is not something I wish to discuss in this article. Ideally, as a property investor, you should naturally be targeting highly desirable properties in the first place. What I wish to discuss here is to improve your odds of demanding a better rental yield than your competition who is also in the same residential compound – the same location, nearby amenities and accessibility. In my opinion, the below points are things we can emphasize to do just that,
- Targeted design and furnishing
- Purchasing additional parking lots
- Pictures that accentuates the unique points of the property
- Partnering with great property agents
- Filtering potential tenants
- Encourage long term tenancy
#1 Targeted design and furnishing
The marketing phrase “if you market to everyone, you market to no one” is very real and very applicable to the rental market. If you do not understand who your rental property is targeting, it makes it really difficult to have a wholesome design that fulfils your tenants’ needs. Subsequently, it becomes rather difficult to attract potential tenants.
From my observation, there are generally 3 categories of tenant groups, each with its unique requirements,
- The family – a household of 3 to 4 individuals
- The couple / newlyweds
- Students / friends – can be a group of young adults staying together
The family – Mother, father and children
Family tenants will often require a place with at least 3 bedrooms – A master bedroom for the parents and 2 single rooms for the kids. The kitchen will also become a key focus for the family as it is the place where communal meals happen.
If you are a landlord and you are looking to target the family group, perhaps more attention should be placed on the kitchen. Having an open kitchen concept with an island as the divider between the kitchen and living room will attract families to your listing.
The couple / newlyweds
Couples or newlyweds tend to place more emphasis on having a comfortable living space. Having a timeless design for the living space, complete with comfortable sofas can be a key attraction for this category of tenants.
Most newlyweds will consider either the studio units or 2 bedroom units. In my opinion, having a 2 bedroom unit can be a better investment in the long term. The master bedroom will be the main place for rest while the single room can be adapted for a working space. Having the 2nd bedroom also gives the young couple the space for a third member – a newborn. If the newlyweds do decide to settle down with a child, the 2nd bedroom can be fitted into a baby’s room for the new family member.
The students / friends
The students and friends category is what I consider the highly price-sensitive group of tenants. The main reason for friends to be staying together is ultimately to reduce individual expenses, keeping to a low budget. In most cases, the rental property will be fitted to accommodate 4 – 8 individuals.
If you are looking to target this group of tenants, perhaps it is ideal to place more emphasis on the bedrooms to fit more individuals. Having a unit that is designed and well catered to accommodate more individuals will likely attract this group of tenants to your rental properties.
#2 Having an additional parking lot
According to the 2017 Malaysia Auto Consumer Finance Study, the average Malaysian household today owns at least 2 cars. Compared to the early 20s, the average household today require more space to park their cars and having sufficient parking lot is becoming one of the main consideration when looking for a rental property.
Listing platforms such as iproperty.com is doing significantly better than their competition (propertyguru.com, ibilik.com, and etc) because they do display the number of parking lots that comes with the rental property. In my experience, a 3 room condominium unit tend to rent out faster if it comes with 2 – 3 parking lots. At the same time, these units also demand better rental returns if fitted with more parking space.
If you are to consider the parking lots as an asset, they do actually have a significantly higher rental return compared to most rental properties. While it is uncommon these days to purchase a parking lot, it is still possible to buy parking lots from the condominium management team. In Malaysia, the typical cost to purchase a parking lot is RM10,000 with an expected rental per month at RM150, giving you a good annual rental yield of 18% with little to no hassle and maintenance cost.
#3 Master the art of interior photography
If you want to get your rental property tenanted as soon as possible, one of the main skills you should master is interior photography. Tenants are easily attracted to well-taken pictures that accentuate the property’s unique value.
It is really unfortunate that after so many years of mobile phones and the conveniences of taking pictures on the go, the listings we see today do not provide any helpful pictorial reference to the rental property. Having a poorly taken picture not only fails to highlight the comfort your rental property can provide, but it might also chase away potential tenants if otherwise, would have given your property serious considerations.
Hence, I believe it is essential for any aspiring landlord to master the art of interior photography. A good picture tells a thousand words and in the rental business, it attracts quality tenants and gets your place rented out quicker than the competition.
#4 Partnering with skillful property agents
Almost all successful property investors who are in the rental business have a good network of successful property agents. Property agents exist to help you save time by showing the rental property to potential tenants and also help filter out tenant profiles according to the landlord’s requirement.
At the same time, property agents also serve as barriers to protect the landlord’s privacy and interest. Hence, a good property agent should have the following experience and skillsets,
- Having the right experience and area specialization to market your property
- To be able to consult and advise the landlord on matters that will help get the rental property tenants quickly
- To be able to filter the tenant profile on behalf of the landlord
- To manage a negotiation on behalf of the landlord, without compromising the landlord’s interest
I believe it is very much possible to market your property without the assistance of a property agent. However, having the right property agent to help you through the hassle can be a worthwhile expenditure, especially when time is a precious resource.
#5 Filter out potential tenants that do not fit your values
When you rent out your property, you are entrusting the property to the tenants who will make your property their home for the foreseeable future. If you entrust it to the wrong party, it is very possible to have returned a damaged property that requires a lot of money to repair and that can dampen your net rental yield for the rental property.
Hence, it is ideal to have at least a system to filter out any potential tenants to make sure that they fulfil your expectation. Ideally, you will want to rent your property to a tenant who will take care of your property as they would their home. Below is my simple recommendation of what needs to be included in your filtering system,
- Employment details – Tenants must be able afford the rent and their monthly income should at least be 3 times the rent.
- Willingness to pay on time – Credit report can be one of the qualifying document to show if a potential tenant has the tendency to be late on their repayments.
- Cleanliness and housekeeping – Take a quick peek into their cars. If the car is not well-kept, chances are that they will do the same to your property.
Generally, screening a tenant’s profile is important. If you are able to rent out your rental property to good tenants, chances are that the property will be kept well and properly maintained in their care. This is important to us as landlords as it helps to keep maintenance and repair expenses to a minimum.
#6 Encourage long term tenancy
Every time you list your property out for rent, there will be a cost associated with it. Typically, it is the cost of advertising, the property agent’s commission upon the successful transaction, the regular upkeeping to keep the place clean for a potential viewing and the opportunity cost for when the property is vacant.
If I am to give an estimate, the associated cost to list and rent out the property is at least 1 – 2 months’ worth of rental income. Now, imagine if your tenants are move out every year upon the completion of the tenancy agreement, you are essentially spending 2 months worth of expenses to gain 12 months of income. This is a whopping 15% spent on advertising and getting the place rented out.
On the flip side, if you are able to get a long term tenant to stay with you, for an ideal situation of 4 years. Mathematically, you are only spending 2 months worth of expenses to gain 48 months of income. Now, this reduces the advertising and listing expense from 15% to now 4.2%.
Hence, it is always ideal to get your tenants to renew their tenancy agreement with you. This will really help to save up on the expenses needed to list and advertise your rental property. Subsequently, you will be seeing a better net rental yield from your properties.
Will rental yield improve over time?
Rental yield will likely improve over time with inflation. Historically, the period between 2008 – 2012 has seen the highest increase in rental rates, as with property prices in Malaysia. Any property bought before these periods will experience a significant increase in its rental yield.
What does this mean for properties after 2012? Truth to be told, we have not seen any improvement when it comes to rental yield for properties bought after 2012. In fact, property prices are observed to have stagnated and in some cases, declined throughout 2018 – 2021, primarily driven by the Covid-19 pandemic.
I do not want to advise based on speculation, but there are analyses made by property observers expecting significant inflation for the recovery years after the Covid-19 pandemic. We are also seeing a trend where the basic daily needs are also a lot more expensive today as compared to the months prior to Covid-19. Hence, I believe there is a real possibility that the rental rate will increase, driven by global inflation.
On the other hand, if you want to have a net income from your rental properties, I would recommend the below tips,
- Finance your rental property to the maximum allowable margin using flexi-loans.
This will allow you to contribute more every month to your repayment, reducing the interest charged on your property in the subsequent months.
On the other hand, the excess funds paid into the flexi-loan can also be taken in times of emergency, giving you better liquidity to manage your personal finances. - Pay more every month that you are required.
If your property is tenanted, then I would recommend that you treat the rents as a business income and is poured back into the flexi-loan.
Combine that sum with your own paying capability, you will be able to quickly reduce the capital used in calculating the interest charged on the property. - After a few years of doing this, you will notice that the monthly instalment for the property is significant reduced.
This way, the future rental income from the property will be more than sufficient to cover for the monthly instalment. Hence, giving you a net income per month.
Final Words
Rental yield is a simple tool to understand if a rental property will potentially give good rental returns over the purchase cost. While it is ideal that a rental property gives a return rate of 1% – 2% on top of the mortgage interest rate, having a 4% – 5% rental yield can also be considered for an investment property.
I hope the above article has been helpful to help you understand the calculation behind rental yields (gross and net) and the different ways to improve your rental returns for your rental properties.
Until then, take care.
