A property that “yields 5.4%” may leave you 2.6% a year. The three measures and when to use each.
Key findings
- Gross yield: annual rent divided by price. In the example, 5.4%.
- Net yield: after costs, empty months and purchase costs, it falls to 3.5%.
- The 10-year IRR ranges from 2.57% with no price growth to 5.66% with a mortgage, which also magnifies risk.
Three ways to measure the same investment
When someone says a flat “yields 5%”, they almost always mean the gross yield. It is the easiest to calculate and the furthest from what you really earn. To decide, you need two more: the net yield and the IRR.
Gross yield
A year's rent divided by the price. A hypothetical property costing 200,000 let at 900 a month brings in 10,800 a year: a gross yield of 5.4%.
Net yield
Subtract what it costs to own the property and divide by what you really paid. If taxes and purchase costs bring the total to 224,000, the property is let 11 months a year and fixed costs (service charges, insurance, upkeep…) add up to 2,000, you collect 9,900 and keep 7,900. The net yield falls to 3.5%, still before income tax.
IRR: the one that tells the whole story
The IRR includes the whole journey: what you put in at the start, what you collect each year and what you get back when you sell. With the same property over 10 years:
- If you only get the 200,000 purchase price back when you sell, the IRR is 2.57% a year: the purchase costs are lost and outweigh the rent.
- If the property gains 2% a year and selling costs 3% of the price, the IRR rises to 3.99%.
- With a 160,000 mortgage at 3% over 25 years (a payment of 758.74) and the same price growth, you put in 64,000 and the IRR on your money reaches 5.66%. But the rent does not cover the payment and costs: over 10 years you would have to add another 12,049 of your own. For the property to pay for itself, the rent would need to be about 1,010 a month.
These are hypothetical figures, with no tax and constant rent and costs. A mortgage magnifies returns when things go well, and losses too if prices fall or the property sits empty.
What to check before buying
- Work out the net yield with every cost, including empty months and your country's taxes.
- Compare it with alternatives of similar or lower risk, such as a deposit or a fund.
- Make sure you can pay the mortgage if the property has no tenant for several months.
Run your numbers with the rental property calculator and, if you borrow, check the payment in the mortgage calculator.