What is yield?
If you want to invest in real estate, you need to know about yield. It’s the term for the annual income generated by one of your investment properties. Yield is a percentage of the total amount an investment costs or its current value. Why is yield important? Because it measures the future income on a property and tells you whether you made a successful investment.
There are two ways to calculate yield in real estate. The first is “levered” yield, which considers the income you earned from a property after paying for any loans or finance on that property. The second is “unlevered” yield, which just measures income and not financing costs. You can choose either one to calculate yield, depending on whether you consider debts and interest as costs.
Homeowners and investors like you typically use this formula to work out yield:
Yield = annual income generated by a property / total cost of property
The total cost of the property can be the price you paid for the asset or its current market value, although most investors and homeowners use the former.
So why should you care about yield? It’s one of the best calculations to determine whether an investment provides value. If you have a portfolio of properties, you can calculate the yield for each one and figure out which asset generates the greatest returns.
Generally, the higher the yield, the better the investment! That’s because high yields mean more income and, therefore, lower risk. A low yield suggests your real estate asset isn’t generating sufficient income every year, which means it might take longer to make a profit on that investment. However, this isn’t always the case. A yield may be high because a property has depreciated (dropped in value). In a healthy market, 5-8% is a healthy yield.
Yield case study
A real estate investor purchased a house for $500K. She spent a further $100,K dividing the property into three separate apartments. In total, she spent $600K. In the first year, she generated $60K in rental income and service charges. The property has a yield of 10%, suggesting the property is a very good investment. The investor can use this yield to predict the future income that the property will generate.
The bottom line
Yield is a formula that predicts future income on a real estate investment. Expressed as a percentage, it works out annual income that comes from a property in relation to the amount an investor or homeowner paid for it.
Yields that range from 5-8% are healthy; those more than 8% suggest an extremely good investment. However, a yield can be high because a property has depreciated.