On the essence of yield and risk
Gross yield and net yield
When considering real estate investment, the first thing many people focus on is “yield.” Yield is almost always displayed in real estate advertisements and property information, and it is not uncommon for people to make investment decisions based on that figure. However, there are several types of yield, and if you do not correctly understand the meaning of the numbers, you may make incorrect investment decisions.
Particularly important are “gross yield” and “net yield.” Gross yield is widely used as an indicator to easily show the appeal of a property, but it does not necessarily accurately represent actual profitability. To judge true earning power, it is necessary to consider the net yield, which includes expenses, taxes, and tax-saving effects.
Here, we will explain the yield that is important for real estate investment.
The difference between gross yield and net yield
First, you want to understand the difference between gross yield and net yield.
Gross yield is a simple indicator calculated by dividing annual rental income by the property price. The calculation formula is as follows.
Gross yield = Annual rental income ÷ Property price × 100
For example, if a property costs 30 million yen and the annual rental income is 1.8 million yen, the gross yield is 6%. This calculation is very simple and easy to understand, so it is common for this gross yield to be displayed in real estate advertisements and the like.
However, there is a significant problem with gross yield. That is the point that no expenses are taken into account at all. In actual real estate management, various costs occur, such as management fees, repair costs, fixed asset taxes, insurance premiums, and vacancy losses.
Therefore, what becomes important is net yield. Net yield is calculated based on the profit after deducting these expenses. The general calculation formula is as follows.
Net yield = (Annual rental income – Annual expenses) ÷ (Property price + Purchase expenses) × 100
In other words, net yield can be said to be an indicator that shows a figure closer to actual profitability. In real estate investment, it is important to evaluate properties based on this net yield.
Yield that takes tax-saving effects into account
Taking it a step further, the profit from real estate investment is not just simple rental income. Tax-related effects can also be included in your considerations to see the true yield.
In real estate investment, you can utilize a mechanism called depreciation. Buildings are considered to decrease in value over time, and that portion can be recorded as an expense. Since this depreciation expense does not involve actual cash expenditure, it has the effect of reducing taxable profit.
For example, suppose the annual rental income is 2 million yen and the expenses are 1 million yen. Subtracting expenses from rental income leaves a profit of 1 million yen. For a person who is taxed at 40% combined for income tax and resident tax, 400,000 yen is deducted as tax from the 1 million yen profit. However, if 1 million yen in depreciation can be recorded, the taxable profit becomes 0 yen, and since there is no profit, no tax is incurred. Therefore, when depreciation is taken into account, the 400,000 yen tax that would otherwise be deducted from the 1 million yen profit is not, so the 1 million yen profit remains in hand as is.
As a result, the after-tax cash flow is improved. In other words, in real estate investment, it is also important to consider not just simple yield, but after-tax net cash flow.
By considering such tax effects, you can grasp the earning power that cannot be seen from superficial yield alone.
Points that beginners misunderstand
One of the points that real estate investment beginners often misunderstand is judging a property based solely on the yield number.
For example, when looking at a property listed with a 10% yield, many people feel that it is a “highly profitable property.” However, if that yield is a gross yield, the actual profit may be significantly different.
Points to be particularly careful about are cases such as the following:
・Vacancy rate is not taken into account
・Repair costs and management fees are not included in the calculation
・Purchase expenses are not included
・Future repair costs are not anticipated
Also, while properties in rural areas may have high gross yields, actual profits may drop significantly in areas with high population decline or vacancy risks.
In other words, in real estate investment, “high yield does not equal a good investment.” It is necessary to make a comprehensive judgment regarding the property’s location, demand, management status, future market environment, and so on.
