Rental yield when buying an investment property

When you are weighing a shortlist of very different properties — a unit here, a house there, different prices, different rents — raw prices and rents are hard to compare. Yield collapses each candidate into a single rate, so you can line them up and see which brings in the most income per dollar of capital committed. That is its job at this stage: a fast, honest first filter.

It is only a filter, though. Yield says nothing about growth prospects, and a purchase decision made on yield alone tends to steer you toward exactly the slow-growth markets where yields are highest. Use it to screen, then bring in the other factors before you commit.

A pre-purchase yield is the expected annual rent over the likely purchase price. Both inputs are estimates, so the discipline is to be conservative on each: use a realistic price (what it will likely sell for, not the advertised guide), and an achievable rent (what comparable properties actually let for, not the top of the range).

The rental yield calculator does this in seconds, and for overseas purchases the international investment property calculator handles the currency side.

Better still, work the other way around. Decide the yield you need first, then let the yield-based purchase price calculator turn a tenanted listing's rent, lease and your renewal and vacancy assumptions into the purchase price range that actually hits that yield — so you walk into the negotiation with a number, not a hope.

Buyers scrutinise the purchase price and take the rent estimate on trust — which is backwards, because the rent is the number most often inflated. A selling agent's “rental appraisal” is not a lease. Before you rely on it:

The most common comparison error is mixing bases — ranking one property's gross yield against another's net, or an optimistic rent against a conservative one. Put every candidate on identical footing: the same yield type (net for a real comparison), the same vacancy assumption, and rent figures sourced the same way. Only then is the ranking meaningful.

See gross vs net rental yield for why a like-for-like comparison has to be net against net.

A pre-purchase yield well above the market for that type and area is a question, not a prize. Markets price risk into yield, so an unusually high figure usually signals something: weak or negative capital growth, a single-industry town, oversupply, a short-lease or student-accommodation asset, or a property that will be hard to resell or finance.

Once yield has narrowed the field, the purchase decision needs the factors yield leaves out. Capital growth prospects often matter more over a long hold — see rental yield vs capital growth. And because yield ignores your loan, the property that actually fits your budget is decided by cash flow: a respectable net yield can still be sharply cash-flow negative under a large, highly geared loan.

So run the cash flow calculator on your shortlisted candidates before you offer — yield tells you how hard the property works for its price, cash flow tells you whether you can comfortably hold it while it does.