For any given rental property, there is a single statistic that, in the end, is the defining factor of that property’s success: its rental yield. The rental yield of a property is calculated with a fairly simple equation:

Yield = (Annual Income-Annual Expenses)/(Cost of Property + Rehab)

Note that cost of property doesn’t include your mortgage payments — those are part of annual expenses. The cost of property does, however, include absolutely everything you will have to pay for before you can start renting the property out, including down payment, closing fees, costs of all renovations, costs of advertising… everything.

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Here’s an Example

So let’s say you purchase a house for \$120,000, but you only put \$30,000 down. A typical 30-year mortgage at 4% would have you paying \$420/month for the other \$90k (this is NOT a rate quote APR, mortgage police!). Then you hire a property management company to handle the details for you, and they charge 10% of your monthly rent amount. You set your rent at a quite reasonable \$1,000/month, so the property management company takes \$100/month to take care of the house. You pay an additional \$280/month for various forms of insurance, a rainy-day fund in case of emergencies, and basic maintenance costs.

Related: The Pivotal Factor You Probably Don’t Know to Watch for in a Rental Market

So now you know that your annual rent is \$12,000, and your monthly expenses are:

\$420 (mortgage)

– \$100 (property management)

+ \$280 (maintenance and insurance)

——————–

\$800

x 12 (to arrive at annual expenses)

——————–

\$9,600

So, you have \$12,000 in predicted income minus \$9,600 in predicted expenses, giving you a total of \$2,400 for the top number of your equation. Since you paid only \$30,000 down on your home but you also paid \$3,000 in closing costs and \$17,000 to renovate the kitchen, bathroom, it’s a total of \$50,000 put in.

So your final rental yield is \$2,400/\$50,000, which divided out gives us a yield of 4.8%.

The Bigger Picture

Knowing the rough yield for a potential investment property is a must! However, it can also be very useful to find out data on historical yields in the neighborhood around your property. Here’s why:

• A neighborhood that has yields of below about 4% tend to be mostly stable, with tenants that stick around. You can expect a longer average tenancy in a neighborhood like this — but of course, that low yield means a longer wait until you start profiting and less profit per year once you do clear that hurdle.
• A neighborhood that has yields of above about 12% can be very difficult to keep tenants in. That high of a yield often means a very elastic housing supply, which means new options pop up frequently and people move more often — especially out of a rental and into an owned home. It can be hard to keep a rental home filled for a long time in such a neighborhood, which can make it meaningfully harder to actually get the yield predicted (because, of course, achieving the predicted yield means having a tenant for all 12 months).
• A neighborhood in the middle — 5%-11% — is generally the best investment in terms of actually maximizing your return.

But keep in mind that we’re now talking about two different numbers — the average yield of the neighborhood is not at all the same as the predicted yield of your property. In the most ideal circumstances, you can match a property with a ridiculous predicted yield (like 16%-20%) with a neighborhood that has a low-but-still-safe average yield (like 7%).

Related: The Ultimate Guide to Analyzing Rental Properties (+ Free PDF!)

That won’t happen. If such a place exists, someone has already purchased it, guaranteed. But it’s the dream, the goal to which it is possible to aspire. This isn’t the last detail I’m going to share with you about yields, so for more of the ins and outs, be sure to check back next time!

What questions and comments do you have about yields and evaluating properties?

Let’s discuss below!

Drew is the manager of Royal Rose Property Management, a fairly high-tech solution for Detroit Metro area property owners & investors.

1. John Underwood on

Just for grins I created a spreadsheet with formulas to calculate my yield for each property.
Mine tuned out to be from a low of 22% to a high of 114%.
Yes the math is correct.
I bought most of my properties via Tax Sale and a couple via a wholesaler.
I have learned to quickly get rid of the nonpaying tenants and take good care of the tenants that take care of me by paying rent on time and communicating any problems.
I have great contractors and handymen that take care of maintenance issues on a case by case basis.
I manage all my properties via text message. My tenants deposit the rent in my bank account so most of my tenants I haven’t seen in 6 months or longer and yet I pay no property manager.
It is all about automating your processes so that your money is working for you and not your for it.
John

• JOHN: sounds like you should be writing some posts:)

2. I put together a spreadsheet when I started investing to compare properties and get an idea of what type of return I should expect. (I wrote about it here https://www.biggerpockets.com/blogs/4970/blog_posts/36159-a-spreadsheet-jump-started-my-investing) I have found it invaluable in getting organized and understanding what areas and properties I should be focusing on. I continuously update it with new properties and those that have sold and now have a list of roughly 200 and growing. Just as you would expect the highest projected returning properties are almost always in areas where you would likely be challenged to get your projected rents. We also have found the sweet spot to be those properties with a projected yield of 10-15%. The property prices are reasonable and the area is decent enough to attract a good tenant base. We use pretty conservative projections so we have been surprised on the upside with lower vacancies and rent increases on most of our properties over the last two years.

• RYAN: thanks for sharing your strategies!

3. Thanks for the post!

• ANDREW: thanks for the comment, keep ’em coming.

4. Drew, there is often a point where the price you paid for the property no longer accurately represents the value of the property. When do you change the denominator in the yield equation to more accurately reflect the situation?

For instance, suppose you live in an area that went through a rather severe housing contraction (I suspect you can relate) and because you knew the neighborhood well and acted quickly when an opportunity presented you were able to pick up a solid rental house for \$50K all in. The house is typical for the neighborhood but you bought it at a great price. You rent the home for several years and you find that the market has come back rather strong–your house is now worth north of \$100K. The figure you would calculate for your yield is twice as high as the going rate in the neighborhood if you use your original purchase price. This situation may also develop, more slowly, if you paid market price for your property but held it for a decade or so. Is there a rule of thumb for when you use the current value of the property to calculate yield instead of the cost?

• JEFF: great question! What you’re hinting at is really a different type of valuation.

Think about a stock you purchase. Your yield is based on what you paid for it. I don’t think one ever changes the purchase price when calculating your overall yield on an investment.

Of course, you would use the current value to track annual rates of return to determine how the investment is performing on a year-to-year basis. I’m sure an investor would have a stronger urge to sell if their investment that was going up 10%+ each year suddenly flatlined or went negative.

5. I agree with your general points and conclusions but there are bad semantics and terminology here that can lead to confusion to those already trying to muddle their way though figuring out real estate jargon.

You defined (net) rental yield, but then calculated a cash on cash return.

So with your example:

Yield = annual income / all initial costs = \$12K / (\$120K + \$3K +\$17K) = \$12K/\$140K = 8.57%

Net Yield = (annual income – annual expenses) / all initial costs = (\$12K – \$9.6K) / (\$120K + \$3K +\$17K) = \$2.4K/\$140K = 1.71%

Cash on Cash = (annual income – annual expenses) / initial cash expenses = (\$12K – \$9.6K) / (\$30K + \$3K +\$17K) = \$2.4K/\$50K = 4.8%

Your conclusions about the best type of numbers to look for to get the best return sound pretty fair to me but for when people refer to a “Cap Rate” (Which is a dubious concept to use for a single family house anyway).
That is CapRate = NOI/ Initial Costs, where NOI = income less all non financing expenses.
So for your example we get:
CapRate = \$7440 / \$140,000 = 5.31%