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Is covering property costs with rent a sure winner? You need to understand this number!

Many investors see rental property in New Zealand as a sure winner. It can serve as a long-term investment, delivering gains as property values rise, while steady rental income helps cover ownership costs. It offers the potential to preserve and grow capital, alongside stable asset returns and a way to save.

As a result, more investors are entering the property market. However, only those who understand the following basic concepts can make the most informed investment decisions.

What is return on investment (ROI)?

Return on investment, or ROI, measures the money or profit an investment earns as a percentage of its cost. It can be applied to virtually any investment product, including shares, bonds and property.

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The general formula for calculating ROI is:

Return on investment (ROI) = annual profit or average annual profit ÷ total investment × 100%

Owning an investment property is like owning a business: your rent, described here as rental yield, is your income. A well-located, well-maintained and reasonably priced property can be a strong source of income. We strongly recommend calculating the rental yield before buying.

What is gross rental yield?

Gross yield is the return on an investment before accounting for expenses, interest or periods when the property is vacant.

The formula for calculating gross rental yield is:

Gross rental yield = annual rental income (weekly rent × 52 weeks) ÷ property value × 100%

For example, a two-bedroom apartment near the University of Auckland measures approximately 65 square metres and is priced at NZ$800,000. Council rates, body corporate fees and insurance average around NZ$600 a month. Similar apartments in the same building rent for NZ$650 a week.

Gross rental yield = ($650 × 52) ÷ $800,000 × 100% = 4.2%

Gross rental yield is commonly used when assessing rental returns because it is simple to calculate and makes it easy to compare properties with different values and rental returns. Its drawback is that it excludes other factors, such as expenses, interest rates and vacancy periods. A property might have a high rental yield but also high maintenance costs that reduce its rental return. This is where net rental yield comes in.

What is net rental yield?

The formula for calculating net rental yield is:

Net rental yield = (annual rental income − annual expenses or lost rental income) ÷ property value × 100%

Using the example above, net rental yield = ($650 × 52 − $600 × 12) ÷ $800,000 × 100% = 3.3%

Expenses or lost rental income may include:

  • Purchase and transaction costs, including the property purchase price, legal fees, building inspections and loan establishment fees
  • Annual costs, such as vacancy costs, including lost rent and advertising
  • Repairs and maintenance
  • Property management fees
  • Insurance
  • Interest

Calculating rental yield can therefore give owners useful figures to refer to when buying, renting out or renovating a property. Of course, investment return calculations involve many variables, so owners are advised to consult a professional before deciding.

Want to know how much rent your property could earn? Want to understand its value in the local market? Contact Barfoot & Thompson.