Dean Graziosi, Contributor to Huffington Post, writes about “The Rent To Value ratio. He says it is a simple calculation. It is the value of a home divided by 12 months of rent. That is the Rental Yield
$175,000 value home rents for $1100/month$175,000 / $13,200 ($1,100 x 12) Rent to Value ratio or Rental Yield is 13.29%
The home is valued at 13.29 times the annual amount of rent it commands in the current market, or the rental yield is 13.29%. Rental Yield is considered one of many ways in which one can evaluate a potential rental property or area. It is similar to the Earnings to Price Ratio in the stock market, the earnings of a stock compared to its cost per share.
I take exception with Graziosi. What he calls Rental Yield is more like a PE ratio. If you bought the rental expecting a 13.29% return on your investment per year you would be in for a rude awakening. To figure the yield on your rental, you would divide the rent for the year, $13,200, by the value or cost of the rental, $175,000. Your gross yield would be 7.5%. Another example: a house sells for $450,000, and the monthly rent is $1,800. The rent to value is 20.83, and the yield is 4.8%.
Like a PE ratio, with rent to value, the cheaper house is selling lower in relation to earnings, and the gross cash yield is higher.
Graziosi says “The idea is that a higher number means that you can accept a lower level of appreciation in value purchasing in an area if this ratio is high. You’ll more than make up for low appreciation over the ownership period with higher cash flow over the expenses of ownership. That is of course if rents hold and you can keep vacancy down.
An example of this is Atlanta, GA. The south side of Atlanta had significantly higher rates of foreclosure than the northern areas of the city. Rental homes on the south side have higher ratios, sometimes double or more “the yields” of the north side. Northern areas of the city fared better during the real estate and mortgage crash that began in 2006. Prices didn’t suffer as much, and home values have been higher over time than those on the south side.
I don’t think his formula says much about appreciation. I would rather buy the lower rent to value and higher cash yield.
Mortgage Choice says, “It’s important to understand that current or historical rental yields are not necessarily accurate indicators of future performance, especially in a heated property market where prices are soaring, but rental prices are stalling.”
“Also, gross rental yield, defined as Gross rental yield = (Annual rental income / Property value) x 100, does not take into account any expenses associated with keeping the property. So, a property with high rental yield but also high expenses may result in a low net rental income.”
In summary: Be sure to define your terms, Rental yield can mean different things. When anyone quotes percentage returns that are quite a bit higher than bank rates and treasuries, dig deeper.
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