The “yield” of a property is the annualised rental income expressed as a percentage of price.
Yield % = Rental Income / Price
It’s a generic term with several variations but all are based on income return, not to be confused with total return.
Total Return = Income Return + Capital Return
Total Return = Property Net Yield + House Price Gain/Loss
Simple enough at the outset, but bear in mind there are several different ways to calculate total return and some tricks people use to make returns seem more attractive. However, what’s important for now is to understand the difference between the income (yield) and capital components and that together they create the total return.
Gross Yield = Gross Rental Income / Purchase Price
Let’s assume a freehold property investment acquired for £200,000 is let to a tenant paying a (gross) rental income of £10,000 pa.
Gross Yield = £10,000/£200,000 = 5.0%
The RICS defines:
|Gross rents||The total income received prior to any deductions for operating costs.|
|Gross yield||The gross income from an investment expressed as a percentage of the purchase price paid for the investment.|
This is the standard definition that we believe the majority of researchers use, but it is silent with regard to whether acquisition costs are included in the purchase price.
The yield we quote makes an assumption to include purchase costs (stamp duty land tax plus a generic costs for legal fee and surveys), we believe it makes more sense to be conservative. It also implies a gross income return from which each property’s operational costs can simply be deducted.
Gross Yield = Gross Rental Income / (Purchase Price + Acquisition Costs)
Gross Yield (LiveYield) = £10,000 / £202,750 = 4.9%
(£200,000 + £1,500 Stamp Duty Land Tax + an allowance of £1,250 for legal fees and surveys)
The difference between net and gross yields
The gross yield is an important starting place for comparable analysis across the country, whereas net yields vary depending on management costs and title. The net yield is, however, the place to start for your return analysis.
Net Yield = Net Operating Income / (Purchase Price + Acquisition Costs)
The net operating income is the gross income the tenant pays, less the associated operating costs expressed as a percentage of the purchase price paid. The commercial property sector talks in terms of net yields albeit in practice all net yields require some interrogation as what has specifically been deducted can be somewhat subjective at times.
|Net yield||The gross income less associated operating costs (net operating income) expressed as a percentage of the purchase price paid for the investment.|
So to get from a gross yield to a net (operating) yield we need to subtract:
Gross Rental Income
- Void period
- Cost of void
- Maintenance (required to maintain rental value. Larger refurbishment projects to enhance value are deemed capital expenditure)
- Managing Costs (external or internal)
- Letting Costs
- Service Charge & Ground Rents
= Net Operating Income