Do you know what you want out of an investment property? Or, have you decided to move from your home to somewhere new and want to keep the original property as an investment?
There are some important numbers to consider that will help you understand the value or potential value of the investment to you, and can help you decide whether to buy or, if you own the property and wish to turn it into an investment, if this move makes the best financial sense. Numbers to consider include: capital growth, rental yield and capital gains tax.
Briefly, if you sell a capital asset, such as real estate or shares, you usually make a capital gain or a capital loss. This is the difference between what it cost you to buy the asset and what you receive when you sell it. (Of course, there are times when selling a property – if it is your principal place of residence, for example - where capital gains tax [CGT] may not apply. Please, always consult an expert, an accountant, lawyer, etc. to check on what applies in your circumstances.)
Capital gains and losses need to go into your income tax return and you will pay tax on your capital gains. Although it's referred to as capital gains tax, this is actually part of your income tax, not a separate tax.
Capital growth is the increase in value of your property portfolio over time. Capital growth can be driven by many things but supply and demand is a major influence. Assessing capital growth is complex but one way to get an idea is by comparing the price you paid for your place when you bought it against the price a comparable property in your area is achieving now.
Calculating the potential rental return on an investment property is a key step in the purchasing decision process. The rental yield is an important indicator of how a property is likely to perform and the cash flow it will generate. It’s a calculation that allows you to quickly decide if the numbers will stack up for you, and if you can afford to service a loan on a particular property. It should be noted that this is a general guide only – you should consult a professional accountant and/or financial planner before proceeding with any investment or tax strategy.
Rental yield is the rental income of a property, expressed as a percentage of its value. It can be calculated in gross terms (before expenses), or as a net percentage (with expenses factored in).
Gross rental yield = (Annual rental income / Property value) x 100
Sometimes gross rental yields are calculated as a percentage of the original purchase price, rather than the market value. This can affect the outcome.
Overall, the gross rental yield offers a simple way to compare properties quickly. It gives you an overview of how the rental income compares to the value of the property and how likely it is to generate a positive or negative cash flow. However, it does not take expenses into consideration. For that reason, a lot of investors use the net rental yield as a more accurate way of assessing returns.
Net rental yield = [(Annual rental income – Annual expenses) / Total property cost] x 100.
The net rental yield offers a clearer indication of whether you can afford an investment property, as it factors in your expenses. To work it out, you’ll need to calculate or estimate your total property costs and total annual expenses.
Total property costs could include: The purchase price/ market value; Stamp duty; Conveyancing fees; Building and pest inspections; Loan establishment fees; etc.
Total annual expenses may include: Property management fees; Rates and water charges; Strata levies (if applicable); Insurance; Mortgage interest repayments, etc.
Calculating the net rental yield can be tricky, given you need to understand the costs of buying and running an investment property. If you’re stuck, please get in touch with a qualified accountant to help you crunch the numbers.
Yields Versus Capital Growth
While strong rental yields are great, it’s important to remember that they’re not necessarily the be all and end all of a property investment. Some investors opt for a lower yield but focus on buying property that is likely to experience capital growth.
Whatever your wealth strategy, you should always consult a qualified financial planner or tax consultant before proceeding.
For more on preparing to invest in property and some helpful calculators, see here.
This article is of a general nature only and before taking any actions you should always seek your own professional advice as is necessary to your particular circumstances.