Real estate can be one of the most rewarding and profitable investments out there. In order for a property to turn a profit, though, there is an important balance you must strike. If you aren’t collecting more in rent than you are spending on your mortgage, an investment property can quickly become an unforeseen expense.
In order to strike this balance favorably, it’s important to understand two important concepts. Rental yield and rentability. While these two terms may sound similar, they describe two very different but important measurements.
Read on to learn all about rental yield and rentability, and how to make sure your investments have plenty of both.
What is Rental Yield?
The ideal investment property is one where your tenants end up paying the majority of your home loan for you. This is what rental yield measures. Essentially, rental yield measures your annual rental income as a percentage of a property’s cost.
For example, let’s say a property you own cost $1 million and your annual rental income is $30,000. Dividing $30,000 by $1,000,000 will give you a rental yield of 3%.
It’s worth noting, however, that this is your gross rental yield. Gross rental yield does not take into account other expenses that come along with owning a property. Costs such as property taxes, maintenance expenses, bills, and your mortgage interest rate are excluded. As a result, the gross rental yield of a property tends to be overestimated.
Instead, it is more useful to look at your net rental yield. Net rental yield measures your actual return on investment. In order to calculate your net rental yield, you’ll want to subtract any expenses associated with owning and managing the property from your annual rental income. In the example above, if you spend $3,000 every year on fees and additional expenses, then your net income isn’t $30,000, but $27,000. Consequently, your net renter yield would be 2.7% as opposed to your 3% gross renter yield.
What is Rentability?
The term “rentability” may sound similar to rental yield, but it measures something entirely different. While renter yield is a measure of income, rentability is a measure of how easily you can rent a property.
It’s common sense that if you can’t rent a property you aren’t going to make any profit off of it. A house or condo that is easy to rent, on the other hand, can be a real money maker. This is because, every month that property stands vacant, it isn’t generating any profit. Not only are homes with high rentability easier to rent, but tenants are likely to keep their leases for longer. A home or commercial property that is easy to rent will always make more money over time.
Anytime you are considering purchasing an investment property, you want to ask yourself “how easy will it be to find tenants for this property?” Many factors can affect the answer to this question, and thus affect a property’s rentability. If a rental market is saturated with two-bedroom condos in a particular building or area, it might be harder to find regular tenants. Or if a unit is older and has obsolete features such as tiny closets or outdated bathrooms, these elements will likely negatively affect a property’s rentability.
High Rental Yield, Low Rentability
While there are plenty of instances where rental yield and rentability are correlated, this isn’t always the case. It’s entirely possible to have high rental yield and low rentability or vice versa.
For example, if an investor purchases a property with 30 years of lease remaining. Here, the investor is able to purchase the property at a lower cost. As a result, there’s a good chance of having high rental yield, since this is measured as a percentage of the property’s cost.
While purchasing such a property might be a tempting way to make a solid profit, there is plenty in this scenario that could go wrong. A property with 30 years of lease remaining might be of sub-par quality. If the home is outdated, or worse has structural damage or problems, this will likely affect the home’s rentability. As such, it might be a challenge for the landlord to find regular tenants.
Low Rental Yield, High Rentability
On the other hand, there are certain properties with low rental yield, but high rentability. This is often the case with high-end and expensive properties.
Let’s say that an investor buys a brand new condo in a hot building in Punta Pacifica. Given the home’s fabulous amenities and prestigious location, this property would likely have very high rentability. However, since the property was so expensive to begin with, it would be hard to make enough profit in rent to generate a high rental yield. Even if you’re making $50,000 a year in rental income, that only generates 1.7% rental yield if a property cost $3 million.
This is why it’s important to think beyond just rentability when choosing an investment property. Carefully considering both of these factors together will help you find an investment property that can really turn a profit.
It Is Easier To Improve Rentability Than Rental Yield
The good news is that neither of these measures is fixed. Both can change given fluctuations in the market and changes made on your part.
In general, it is easier to increase the rentability of a property than it is to increase the rental yield. In order to increase the rental yield, you need to do one of two things. The first would be to increase your annual rental income. This can be achieved by raising the rent. However, there is a limit to how much you can drive up rent prices without losing tenants and decreasing rentability.
The second way to improve rental yield is to reduce the cost of your investment property. This isn’t so easy to do. Apart from refinancing your loan to get a lower interest rate, there’s no real way to reduce the cost of a property you already own. This is why improving rental yield is hard to achieve.
How Can You Improve Rentability?
You can, however, improve the rentability of a property. Obviously, a full-scale upgrade and renovation of a home is going to make it more appealing to renters. Unfortunately, though, if you’re looking to increase your profits, pouring a ton of money into a renovation isn’t usually the wisest choice.
That said, oftentimes you can make smaller changes or upgrades to a home that can have a big payoff in terms of improving rentability. The secret here is to know the demographics of who you’re aiming to rent to. Depending on what neighborhood your property is in and what sort of home you’re renting, there are certain features that can be appealing.
For example, Panama’s financial district tends to house a substantial number of foreign employees who may be staying in Panama on a more temporary basis. In this case, a furnished apartment is going to have much better rentability than an unfurnished one. Aiming to rent to families with young children? Installing simple safety features such as childproof cabinet closures can be a huge selling point.
In addition to these demographic-specific upgrades, there are also some housing features that everyone can appreciate. There are many creative and easy ways to add more storage to a home that all renters will enjoy. For older units, a fresh coat of paint or upgrading the hardware on cabinets can go a long way in making a unit feel more contemporary.
This is one area where it’s often a good idea to work with a property manager. Having a trustworthy property management company at the helm when dealing with rental properties means someone is constantly aware of your property’s maintenance needs. A good property manager will also have a solid grasp of your target demographic of renters and will help you be savvy about making upgrades that will get you the biggest bang for your buck.
Be an informed investor and think about these two measures the next time you’re eyeing a prospective purchase. Having a solid understanding of rental yield and rentability can help you be a more savvy investor. And working with a property management company such as Panama Equity can help you make sure your investment is paying for itself and then some.