Cutting Through The Maze: How To Calculate Property Yields (Part 1)
Are you curious about your property’s net yield and whether your investment is still worthwhile? The COVID-19 pandemic has impacted the economy and the property market. It might be a good idea to conduct an assessment. If you’re unsure how to calculate your property’s yield, we can help. Keep reading to find out more.
Simply put, a property’s yield shows the rate of return an investor would get on his investment and is expressed as a percentage of the property’s cost or market value.
Yield = Annual rental/ Cost or market value of property * 100
We use this formula to compare with returns of other properties. However, an investment could be overrated without deducting the outgoings. To compare with returns on other types of investments, such as shares and bonds, we use another method of comparison: return on investment (ROI). I have included a brief explanation of ROI in the later part of this article.
Yield expectations differ according to the type of property. Generally, landed properties have lower yields than strata properties because the landed ones have better capital appreciation. Therefore, a lower rental return is acceptable. The appreciation makes up for the low yield when the property is sold. Commercial properties are expected to have higher yields as capital appreciation is lower. Higher expectations are placed on yields for riskier investments, so fixed deposits in banks have low returns. This is a general rule of thumb. Of course, there are a few exceptions to the rule in practice.
What to deduct as outgoings?
Outgoings include more than just the expenses needed to upkeep a property in good condition. In Malaysia, tenancy agreements are currently unregulated, and it’s up to the parties involved to determine who will be responsible for different costs based on market practices, which can vary depending on the type of property.
In part 2 of this article, I have included the outgoings specified in my tenancy agreement. Standard outgoings for a non-strata property, such as a house, are as follows:
Standard outgoings for a non-strata property, such as a house, are as follows:
Repairs
This includes immediate repairs and estimated annual expenses, such as repainting the exterior every 5 years.
Major repairs
If the property requires significant repairs, the current cost of these repairs can be subtracted from the capital value.
Sinking Funds
For buildings nearing the end of their useful life, it may be practical to make a provision for an annual amount to reinstate them.
Assessment rates and quit rent
Assessment rates are payable twice a year to respective local councils for properties located within their jurisdiction. The amount is a percentage of the property’s annual value, which is an estimated gross annual rent based on market valuation. Rates are collected for the maintenance and upkeep of the city or region.
Quit rent is a form of land tax imposed by state governments, and it varies according to state, location and category of land use.
Fire Insurance
This allowance can be based on the actual annual premium or an estimated amount for fire protection. (Additional insurance may be needed for commercial properties with a glass façade to protect against damage.)
Void Allowance
When calculating the net rental for a building with multiple occupants, such as an office building, an allowance for vacancies is typically made if the building is not fully occupied. This percentage can be based on the actual occupancy or an estimate.
There will be void periods between tenancies for individual properties like houses or condos. The length of tenant stays can vary from 1 to 3 years, depending on the property type and tenant. There is no standard annual void period to follow. Tenants can also renew their leases. Under normal market conditions, finding a tenant can take up to three months. Sometimes, it can take longer, depending on the property type and location. In a poor market situation, long void periods can significantly reduce the yield and erase any profits, making the investment unviable.”
Water, electricity and sewerage charges
Tenants usually bear these costs; however, if the lease terms state that the landlord is responsible for covering the expenses, they must be deducted as outgoings unless they are recovered through a service charge.
What’s not included?
When comparing property yields, the focus is on the quality of the investment and excludes personal costs such as taxes. The ones described below differ for each investor and are not necessarily incurred in every transaction.
Many owners rely on real estate agents to secure tenants and have to pay the agency commission. In some cases where the landlords are not around, agents assist in collecting rentals and managing the property on their behalf. A separate management levy is payable for this service.
It is contended that even if the landlords are doing these themselves, an allowance should be made as their efforts are considered an opportunity cost and must be accounted for. However, the practice here in Malaysia does not usually include them in the outgoings.
Investors must consider certain costs for overseas properties if they rely solely on agents to rent out and manage the property—for example, small, fully furnished studio units in Bangkok experience high turnover. Tenants with many options may easily move to another unit after one year. In addition to the one-month rental agency commission, the investor must pay another month’s rent if the agent manages the unit. Also, there is a void period to consider. It’s unrealistic to expect that another tenant would be secured immediately.
Acquisition costs associated with purchasing a property are generally not added to the cost or market value of the property in the computation of net yields. The stamp duty cost for the title transfer is also not included.
Income tax on the rental income and mortgage interests (where a loan is obtained) are not deducted as outgoings.
To derive net yield, the standard outgoings payable by the landlord are deducted from the gross rental income and then expressed as a percentage of the property’s cost or market value.
Net yield = Net rental income / Cost or market value of property * 100
Yields are current indicators and do not consider the property’s capital growth or future uncertainties.
Read part 2 of this article here on what to consider for strata properties and typical tenancy terms and conditions.
Read my next write-up as we crunch some figures to get net yields.
Read my Starproperty article on the definition of market value and what determines it.
