While there are many factors to consider when finding, evaluating, and ultimately buying a rental income property, there is one simple metric that all investors can use to quickly compare across investment opportunities and narrow down their choices.
Gross Rental Yield
This is the annualized gross rents divided by the value of the property. Let’s look at a simple example.
If you have a rental property that can generate $1000/mo in rent and it costs you $120,000 to acquire it, then your gross rental yield will be:
$1000/mo * 12 months = $12,000 annualized gross rent –> $12,000 annualized gross rent / $120,000 value of property –> Gross Rental Yield = 10%
But there are several important caveats to using this metric.
First, the value of a property is not necessarily the purchase price the property.
If you purchased a well maintained, recently renovated properly that was immediately ready for a tenant to move into, then yes, the value of the property is your price.
But what if you purchased an older property that required some significant renovations? For example, if you purchased the property for $80,000 but had to put $40,000 into major renovations, you should use the $120,000 as the divisor in your gross rental yield calculation rather than the $80,000 figure.
If you’ve owned your property for many years, your purchase price is likely well below the property’s current value.
Second, the metric only captures current information.
The metric doesn’t factor in many of the other important factors in evaluating rental income properties. It says nothing of future rents or property values. It only allows compares the relationship of current rents to current values.
Two properties in different markets may show the same yield using current rental and home value figures but may have very different rental trajectories going forward.
Third, it looks at the top line rental revenue only
Especially if you’re comparing rentals across different markets, the cost of owning and operating rental properties could differ significantly. Vacancies and turnover could differ. Utility rates. Property management fees. Repair and maintenance could differ. Or a property may have a costly HOA fee while another does not.
Yet even with these limitations, the gross rental yield is still useful as a quick and simple metric to compare either compare across rental markets or rental properties.
For example, by using average market rents and home values for different cities, you can quickly access and compare the overall attractiveness of the cities as rental markets. And using these city gross rental yields, you can quickly gauge the relative attractiveness of a specific rental property against the market norm.
Let’s look at several cities using rental and home value data from Zillow, as of Dec 31, 2018.
Average rental rates
Los Angeles = $2,201
Chicago = $1,431
Las Vegas = $944
Looking at the avg market rents alone, we can’t really tell much about the rental markets without also looking at the home values.
Average home values
Los Angeles = $650,200
Chicago = $224,200
Las Vegas = $278,000
Gross rental yields
Los Angeles = $2201*12/$650,200 = 4.06%
Chicago = $1431*12/$224,200 = 7.66%
Las Vegas = $944*12/$278,000 = 4.07%
All things equal, you’re far more likely to get a better overall yield on a rental income property in Chicago than in Las Vegas or Los Angeles. But markets and properties are almost never equal.
In a follow-up post, I’ll identify the Top 30 and Bottom 30 rental markets in the U.S. according to the gross rental yield as well as discuss additional factors to consider when finding and selecting a rental income property.
Do you use the Gross Rental Yield as part of your investment analysis? What other metrics do you use?