The beginning of a successful rental property investment strategy is an accurate estimate of rental yield for the prospective property. Net rental yield takes the property expenses into account, but not debt service such as mortgage payments.
We then look at the same property with the mortgage included and using the actual cash invested. This gives us a cash-on-cash rental yield.
Net Rental Yield
Here’s an example if you’re renting a property for Kes 24,000 a month and it’s unoccupied 5% of the year. The take-out for a vacancy for annual cash-in is Kes 276,000. Now calculate these costs:
- Annual insurance cost: Kes 120,000
- Annual taxes: Kes 140,000
- Annual repairs budget: Kes 60,000
- Rent management fee: 6%
These expenses total annual cash out of Kes 484,200. An income of Kes 2,736,000 minus the cost of Kes 484,200 works out to Kes 2,251,800 in rental income after expenses.
Now let’s say that it cost you Kes 30,000,000 to purchase the property. Kes 2,251,800 divided by the property value of Kes 30,000,000 equals a rental yield of 7.5%.
Net Yield vs. Gross Yield
There’s obviously a significant distinction between these two terms. By itself, “yield” simply indicates the rent generated by property over the course of the year and the percentage it represents of the purchase price. Yields generally tend to be higher in less expensive areas.
Gross yield does not consider expenses—what it costs you to keep that property up and running, including the interest you might be paying on loans and mortgages. You’re left with a rate of return or “net yield” when you subtract these expenses.
Cash-on-Cash Rental Yield
We’ll use the same presumptions here: Monthly rent is Kes 24,000 and property is unoccupied 5% of the year. The take-out for a vacancy for annual cash in remains at Kes 273,600. Now we’ll say that you put kes 6,000,000 in cash into the detail, so you borrowed Kes 24,000,000. The calculation would work like this:
- Payment of monthly principal and interest: Kes 155,664
- Annual insurance cost: Kes 120, 000
- Annual taxes: Kes 140,000
- Annual repairs budget: Kes 60,000
- Rent management fee: 6%
These will total annual Cash Out of Kes 2,352,128. An income of Kes 2,736,000 minus costs of Kes 2,352,100 equals Kes 383,900 cash return over cash out, and Kes 383,900 divided by a cash investment of Kes 6,000,000 equals a cash-on-cash rental yield of 6.4%.
Why It Matters
Net rental yield doesn’t exist in a vacuum, but it can go a long way toward telling you whether investing in a certain property is a wise—or not so wise—move. In simplest terms, it tells you whether you’re paying too much for a property, so much so that you’d find a better rate of return elsewhere.
Risk vs. The Reward
Although few would argue that the stock market can be quite risky in the short term. The inconsistency often corrects and get back on track over time, but you can lose money easily if you can’t wait it out. A little bit of bad news or a bad earnings report can take a stock down hard for a while.
A properly selected rental home will provide monthly positive cash flow and be relatively insulated from bad economic news. Your tenant still needs a place to live even if the stock market just took a dive. You should also be building equity over the long run through value appreciation and paying down the mortgage. This equity can be tapped for other investments.
Return on Investment
Bonds are less risky than stocks, but the tradeoff is low yields. Bond interest for the safer municipal and government bonds is lower than that for corporate bonds, but those aren’t really that great, either. It’s hard to get excited about this type of investing, especially if you’re retired and on a fixed income.
The monthly cash flow of a good rental home can easily provide double the returns of bonds, especially with the tax advantages that you don’t get with other asset types. You can also use leverage with mortgages. Instead of taking Kes 15,000,000 out of bonds to buy a house for cash, you could take out around Kes 3,000,000 for a down payment and stay diversified with a better return on your investment.
NB: The Examples are mere calculations. They may be inaccurate.
