[ideas2earn]

This seems obvious to me but has caused problems for a couple of friends and now my wife.

The numbers are made up to be easy.

You buy a house.
It costs you $100K
You put down $30K deposit
You rent it for $1K a month (12K pa)
Your mortgage is $500 a month (6K pa) interest only

What is your yield?
So many people think the answer is 12% i.e. 12K rent over the value of the property - 100K

I would say the answer is 6K divided by the deposit of 30K i.e. 20%
Thats because your net income is 12k-6k of cost (mortgage) and your total expenditure is the deposit of 30K

If you bought a fixer upper as above and spent $10K on doing it up your yield would move to 15% i.e. 6K divided by 40K

This is very simplified and doesn't take into account depreciation or increases in property value but it realy shows the value of gearing providing you get positive cashflow.

The property in this example wouldn't be a concern if it never went up in value. In truth of course it always will, rents rise with inflation and as the rents go up the value of the property has to rise.

In theory you can value property this way. If you can get 4% in a savings account the property ought to yield 4% if bought for cash, making it worth $300,000. i.e. 12K / 4 to get 1% the multiplied by 100.

Assuming the same deposit %age you would need to find $90K downpayment and the 6K yield would still be more than 50% better than you could do in a savings account at 6.67%