Rental Yield Explained

Rental Yield is a numerical figure that depicts the “return” or how much you earn on an annual basis in percentage terms. The reason why people want to know the return in percentage terms is so that it can be compared to other types of investments.

The rental yield is calculated as the total income you will generate in a year–net of all expenses–divided by the purchase cost. In simple terms, rental yield is net income divided by total acquisition cost.

It’s important to note that investments are typically measured on an annual basis so you’ll have to adjust figures to reflect total income/expenditures per year.

Here’s a simple example.

Let’s say you bought a condominium unit in Park Terraces for Php25 Mn and spent Php2 Mn to furnish the place. You rent it out for Php135,000 per month or equivalently Php1.62 Mn per year. Your rental yield will be 6.0% (Php1.62 Mn divided by Php27 Mn). At 6%, people would think that this investment has an attractive yield.

At most times, this is the way people calculate the annual percentage return from their investment. The problem with this method is it does not capture expenses incurred that pull down the effective return.

Let’s add to the story.

Let’s say you bought a condominium unit in Park Terraces for Php25 Mn on January 1, 2016. Then, you spent Php2 Mn to furnish the place. You got the services of a real estate broker. After 4 months (or on May 1, 2017), you are able to rent it out to a foreigner for 3 years at Php135,000 per month. You pay the broker one month worth of commission for the first year and half month commission for the subsequent years.

You expect to pay monthly association dues (which is typically included in the rental price) of Php15,000 per month (or Php180,000 per year) and Php15,000 of annual tax per year.

After the 3-year lease, you make the place presentable again. You spend Php60,000 for general cleaning, repainting, etc. And after 2 more years, you renovate and re-upholster the furniture, spending Php200,000 in the process.

Now, let’s calculate the yield.

Rental Income. First thing to do is to calculate the income for the first year. It’s important to note that, strictly speaking, the reckoning date/start date should be the time when you’ve paid for the unit. The reason for this is so that you can make an apple-to-apple comparison to another potential investment (e.g. how much would I earn if I spent Php27 Mn on a 5-year corporate bond on January 1, 2016). With this, you are calculating the income for 12 months or from January 1, 2016 to December 31, 2016. For 2016, you have a total income of Php1,215,000 (or Php135,000 * 8 months).

Expenses. You have to calculate all expenses that you will incur. The association dues and real property tax are straightforward. However, one expense most people overlook is the expense incurred in fixing up the place for the next tenant. It would be hard to rent out the unit after the third year if the walls of the unit are dirty and the furniture look worn out. Moreover, newer buildings would have turned over after 3 years, making the rental market more competitive.

Assume an amount for general cleaning and painting and divide this amount by 3 (you assume that you will clean and paint the unit every 3 years). Then, assume another amount for renovation and refurnishing and divide this amount by 5 (you assume that you will re-upholster the furniture every 5 years). For this example, total expenses sum up to Php345,000.

Net Income. You deduct total expenses from total rental income to get the net income.

Rental Yield. Finally, you divide the net income by total acquisition cost (including the cost of furnishing the place). For this scenario, the effective rental yield is just 2.7%–which is dramatically lower than the 6.0% previously calculated!

The table below shows how everything was calculated.

Rate Period Annualized
Rental Income
Rent 135,000 per month 1,620,000 A
Less: Opportunity loss for 4 months 135,000 per month 540,000 B
Net Sales 1,080,000 C = A – B
Expenses
Broker’s Commission Year 1 135,000 first year D
Broker’s Commission Year 2 67,500 second year E
Broker’s Commission Year 3 67,500 third year F
Total Commission 270,000 3 years 90,000 G = (D + E + F) / 3
Association Dues 15,000 per month 180,000 H
Real Property Tax 15,000 per year 15,000 I
Total Taxes Paid 195,000 J = H + I
General Cleaning and Painting 60,000 per 3 years 20,000 K
Renovation and Refurnishing 200,000 per 5 years 40,000 L
Total Other Expenses 60,000 M = K + L
Net Income 735,000 N = C – G – J – M
Amount
Purchase Price 25,000,000 O
Cost of Furnishing the Place 2,000,000 P
Total Acquisition Cost 27,000,000 Q = O + P
Rental Yield 2.7% R = N / Q

For comparison, these are the rental yields from neigboring countries, as reported by Colliers Research:

Screen Shot 2017-09-27 at 11.36.01 AM

Some nice things to point out from this exercise are:

  • The opportunity loss from foregone rent is the single most detrimental factor that can affect the rental yield.
  • And consequently, the one factor that can help mitigate opportunity loss is the rental price.

If we rented out the place at a lower price, say Php110,000, on February 1, 2016, the rental yield goes up to 3.2%. This goes to show that if somebody came along and asked for a huge discount (in this case a 20% discount), it’s still something the owner should consider. This type of analysis is where your trusted broker (*ahem) can help you.

Still, with these types of returns, we can’t help but ask, are all real estate investments good investments? This is something I’ll tackle in my next article.

 

Disclaimer: This material, which is strictly for information purposes only. The views and opinions expressed in this article are those of Juan Patag’s and do not necessarily reflect the position of RE/MAX Capital, or any other RE/MAX franchise. Any information is subject to change without prior notice. No liability whatsoever is accepted for any loss that may arise (whether direct or consequential) from any use of the information contained herein. Information Each RE/MAX franchise is independently owned and operated.

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