This week I had a client come to me with a straightforward brief: find real estate opportunities that could generate higher-than-average returns, working with a relatively modest cash budget, and without taking on debt to finance the purchase.
The investment opportunity the client had identified themselves looked attractive at first glance. Their decision-making was based on a simple calculation of gross yield — annual rental income divided by the purchase price of the property. Purchase price should include any associated transaction costs such as notary fees or taxes. Because it was a cash purchase, mortgage costs weren’t a factor either way.
Gross yield has its merits, particularly for an initial screen and for comparing several properties side by side. But it’s a misleading figure to rely on when deciding on a specific investment. The reason is simple: to work out the actual return, every cost has to be accounted for. Net yield, accounting for operating costs and thus reducing annual income, is a far more useful number when assessing a specific property.
Renovation and maintenance costs can have a significant impact on yield, particularly for older properties. Combined with a relatively low annual rental income, they can have a devastating effect on the return an investor actually realises. As a rule of thumb, it’s worth budgeting 1-2% of the property’s value per year for these costs. For older properties, this number can be as high as 3-4% per year.
Another area investors often overlook is vacancy risk, along with insurance against non-payment and void periods. These costs are usually smaller than renovation or maintenance, but they still “eat” into the yield.
Investors looking at real estate abroad also need to factor in property management costs, which can add up to anywhere between 10-20% of annual rental revenue. Rather than working through each of these costs by hand, you can plug your own numbers into RE-search’s free Property Net Yield Calculator to see gross and net yield side by side.
And finally — there is income tax. In many countries, foreign investors are subject to withholding tax, so understanding the tax implications of a purchase before committing to it is essential. In many jurisdiction, operating costs can be deducted from total revenue, thus reducing income tax due, however, it is worth doing due diligence in advance.
If you’d like help screening opportunities like this one, RE-search offers independent investment advisory for investors looking to make well-informed decisions.