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# What is Gross Yield in Real Estate & How Do Investors Use It?

by Jeff Rohde, posted in Investment Strategy

Gross yield in real estate is a financial metric that investors use to determine the potential profitability of a rental property. By monitoring the gross yield of rental property currently owned, investors can also determine the change in fair market rent to help keep profits strong.

Key Takeaways

• Gross yield calculates the return on a rental property without factoring operating expenses or financing.
• Comparable investments and fair market rent can also be analyzed using the gross yield formula.
• By comparing gross yield to other financial metrics, such as net operating income, cap rate, and cash-on-cash return, investors can uncover the potential value of a rental property.

## What is Gross Yield in Real Estate?

Gross yield – also known as gross rental yield – is the total gross rent collected from a property compared to the property market value or purchase price:

• Gross Yield = Gross Annual Rent / Current Market Value

For example, if a small single-family rental home in Oklahoma City with an asking price of \$60,000 generates a monthly gross rent of \$610, the gross yield would be 12.2%:

• \$610 monthly rent x 12 months = \$7,320 gross annual rent
• \$7,320 gross annual rent / \$60,000 property price = 0.122 or 12.2%

In other words, by purchasing a rental property for \$60,000, an investor would receive a return of 12.2% before paying for items such as normal operating expenses, contributions to a CapEx (capital expense) account, mortgage payment (principal and interest), and taxes.

## Why Real Estate Investors Use Gross Yield

It’s important to understand that gross yield in real estate is not a measure of potential profitability, because the calculation does not take into account the cost of owning and operating a rental property. That means it’s possible for a rental property to have an attractive gross yield, but also have negative cash flow.

For example, assume that the owner of that small house in Oklahoma City had to spend \$5,000 on a new heating and air conditioning system because the unit stopped working in the middle of a summer heatwave.

The gross rental yield would remain unchanged because the tenant is still paying the rent. However, the cash flow for the year would likely be negative, assuming 50% of the gross rent is used to pay operating expenses, before any capital expenses such as a new HVAC:

• \$7,320 gross annual rental income – \$3,660 operating expenses – \$5,000 HVAC expense = <\$1,340> cash flow

Although gross rental yield does have its limitations, there are a couple of good reasons why real estate investors calculate gross yield on a rental property:

1. Compare Alternative Investments

Gross yield is a quick and easy way to compare potential investments to narrow down the options. If a property doesn’t generate a good gross yield to begin with, the cash flow and net operating income (NOI) may also be low.

For example, an investor may require a minimum gross yield of 10% before taking a closer look at potential homes to buy. By dividing a home’s gross rental income by the asking price, an investor can quickly tell if a potential investment could fall into their buy box.

2. Calculate a Fair Market Rent

The gross yield formula can also be used to determine what the fair market rent of a home should be. Sometimes a home has never been used as a rental before, and an investor isn’t sure how much to charge for rent.

By analyzing the gross yield from other comparable properties, the market rent can be calculated by rearranging the gross yield formula:

• Gross Yield = Gross Annual Rent / Current Market Value
• Gross Annual Rent = Current Market Value x Gross Yield

Assume that the gross yield from similar rental properties in the same area is 12%. If the investor paid \$110,000 for a home that has never been rented, based on the gross yield formula the fair market rent should be about \$1,100 per month:

• \$110,000 current market value x 12% (0.12) = \$13,200 gross annual rent
• \$13,200 gross annual rent / 12 months = \$1,100

## A Closer Look at Gross Yield in Real Estate

Before purchasing a rental property, investors calculate the gross yield to help determine if the property is a good investment.

However, determining the gross yield isn’t a one-off calculation. Investors monitor average market rents and property values to track the change in gross yield throughout the holding period, to ensure that the right rent is being charged.

To illustrate, we’ll assume a single-family home was purchased five years ago in the tertiary real estate market of Tucson, Arizona. Using data from Zillow and Zillow Research we can track the change in gross yield over the past five years:

 Year 1 Year 2 Year 3 Year 4 Year 5 Home Value \$200,000 \$216,000 \$228,000 \$248,000 \$308,000 Rent \$1,028 \$1,086 \$1,153 \$1,221 \$1,377 Gross Yield 6.20% 6.00% 6.10% 5.90% 5.40%

Gross yields were averaging about 6.0% per year, up until the last year when it dropped to 5.4%. If fair market rents adjust back up to 6.0%, that would suggest a rent increase from \$1,377 per month to \$1,540:

• Gross Yield = Gross Annual Rent / Current Market Value
• Gross Annual Rent = Current Market Value x Gross Yield
• \$308,000 current market value x 6% = \$18,480 gross annual rent or \$1,540 gross monthly rent

Before increasing the rent, an investor will run rent comparables to determine the fair market rent of similar homes in the same neighborhood or area. This helps to ensure gross rents are competitive and that the property is generating as much potential profit as possible.

## Other Financial Metrics for Measuring Real Estate Return

Gross yield is a quick and easy calculation investors use to narrow down investment options and calculate the fair market rent. But, calculating gross yield doesn’t show how much profit an investment property could generate because operating expenses are not used in the equation.

Once the list of investments is narrowed down, cap rate and cash-on-cash return metrics can be used to analyze the potential profitability of a rental property before deciding to buy:

Cap Rate

Cap rate (also known as capitalization rate) measures the potential return on an investment based on the property’s net operating income (NOI). In some real estate markets, cap rate is also known as net yield or net rental yield.

NOI is calculated by subtracting normal operating expenses, excluding the mortgage payment (principal and interest), from the gross rental income. Once the NOI is calculated, divide that number by the property price to determine the cap rate:

• Cap Rate = NOI / Property Price

Sometimes, a property with a high gross yield actually has a lower cap rate. For example, maintenance costs may be higher or the property tax rate in the county may be larger, which decreases the amount of net operating income.

To illustrate, let’s look at three examples:

 Gross Annual Rent Price Gross Yield NOI Cap Rate Home #1 \$13,000 \$120,000 10.80% \$7,200 6.00% Home #2 \$16,000 \$140,000 11.40% \$7,000 5.00% Home #3 \$13,000 \$130,000 10.00% \$9,100 7.00%

At first glance, Home #2 appears to be the best choice, based on the gross annual rent collected and the gross yield. However, because operating expenses are higher, the cap rate is actually the lowest of the three options.

Cash-on-Cash Return

Many real estate investors finance the purchase of a rental property, which makes cash-on-cash return another good financial metric to use. Cash-on-cash return takes into account the property operating expenses plus the mortgage payment:

Cash-on-cash return is calculated by dividing the annual before-tax cash flow by the amount of total cash invested. For example, if an investor purchased a \$100,000 rental property using a 25% down payment (\$25,000) and the annual before-tax cash flow is \$3,500, the cash-on-cash return would be 14%:

• Cash-on-Cash Return = Annual Before-Tax Cash Flow / Total Cash Invested
• \$3,500 annual before-tax cash flow / \$25,000 down payment total cash invested = 0.14 or 14%

## An Easier Way to Calculate Potential Returns

Calculating the potential return of a rental property by hand can take time, and it’s easy to make a mistake that could lead to the wrong investment decision.

This simple spreadsheet by Roofstock provides an easy way to view the potential financial performance of a given property. You can use it to forecast the potential return of a property. Simply enter some information to view projected key return on investment (ROI) metrics, including cash flow, cash-on-cash return, net operating income, and cap rate.

By combining financial metrics like these with the gross yield calculations, real estate investors can better understand the big picture instead of looking at only one or two measures of return.