There are many ratios investors use to compare rental property investments. To quickly estimate the profitability of an investment, I like to use price rental yield, which can be either gross or net.
- Gross rental yield (%) = (annual rental income / purchase price) x 100
- Net rental yield (%) = (annual rental income – expenses / purchase value) x 100
One popular measurement is the capitalization rate (cap rate), but it requires having detailed income and expenses, which are not necessarily available. It is similar to the net rental yield. The formula is
- Cap rate (%) = (net operating income / current value) x 100
where
- Net operating income = annual rental income – all operating expenses (excluding mortgage payments, depreciation, or amortization)
If you are buying a property, then the current value is usually the same as the purchase price.
According to AI, a “good” rental yield is between 5-8%. I personally target a gross rental yield of about 12%. Let’s see how to calculate rental yield on some properties.
Apartment building in Stockton, California
- Zillow Listing
- Address: 1135 N Sutter St, Stockton, CA 95202
- 8 apartments
- Each apartment is 1 bedroom, 1 bathroom
- Total 4192 sqft (524 sq ft / apartment)
- Zillow Estimate: $766,000
- Sale Price: $800,000
- Estimated rent for a 1 bd, 1 ba apartment in/around 1135 N Sutter St, Stockton, CA 95202 according to Rentometer: $1000
- Actual rental income per listing: 4 units @ $1000 / month, 3 units @ $900 / month, 1 unit vacant
- Cap rate per listing: 8.5%
- Gross rental yield potential: (8 units x $1000 / month x 12 months) / $800,000 = 12%
This property has a potential gross rental yield of 12%, which is good. I would look further into this property as an investment.
Townhouse in Hayward, California
- Zillow Listing
- Address: 841 W Sunset Blvd #B, Hayward, CA 94541
- 1 townhouse
- 3 bedrooms, 2.5 bathrooms
- Total 1448 sqft
- Zillow Estimate: $713,000
- Estimated rent according to Zillow: $3626
- Cap rate per listing: details unavailable to calculate
- Note: This property is in an HOA with monthly dues of $200 / month
- Gross rental yield potential: ($3626 / month x 12 months) / $713,000 = 6.1%
The property has an estimated gross rental yield of only 6.1%, which is closer to the low end of the range of what is considered good. I wouldn’t bother considering this property as a rental investment.
Single-family house in Hayward, California
- Zillow Listing
- Address: 28578 Harvey Ave, Hayward, CA 94544
- 1 single-family house
- 3 bedrooms, 3 bathrooms
- Total 1,709 sqft
- Zillow Estimate: $971,800
- Estimated rent according to Zillow: $3,862
- Cap rate per listing: details unavailable to calculate
- Gross rental yield potential: ($3,862 / month x 12 months) / $971,800 = 4.7%
At an estimated gross rental yield of 4.7%, this is not a good investment. However, if you convert the house into a co-living space, you can increase the rental yield as follows:
- Convert 2-car garage into a JADU with 2 rooms, each of which can be a bedroom
- Convert the family room into a bedroom
- Depending on the house layout, it may be possible to convert other rooms into a bedroom
In doing so, the house would have at least 6 bedrooms, which, at $1000 of rental income each, would bring in $6000 / month, resulting in a rental yield of 7.4%.