What is Current Rental Yield?
Rental yield is a measure used to calculate the return on investment (ROI) from a rental property. It indicates the annual rental income generated by a property as a percentage of its market value. In simpler terms, it shows how much income you can expect from a property relative to its price. This metric is crucial for both real estate investors and lenders, especially when assessing property value for mortgage loans.
How Rental Yield is Calculated:
There are two primary types of rental yields:
- Gross Rental Yield:
- This is a simple calculation that does not take into account expenses associated with maintaining the property (e.g., taxes, repairs, etc.). Formula:
[
\text{Gross Rental Yield} = \left( \frac{\text{Annual Rental Income}}{\text{Property Value}} \right) \times 100
] - For example, if a property worth ₹1 crore generates an annual rent of ₹6 lakh, the gross rental yield is:
[
\frac{6,00,000}{1,00,00,000} \times 100 = 6\%
]
- Net Rental Yield:
- This takes into account property-related expenses such as maintenance, insurance, property taxes, etc. Formula:
[
\text{Net Rental Yield} = \left( \frac{\text{Annual Rental Income} – \text{Annual Expenses}}{\text{Property Value}} \right) \times 100
] - For example, if the same property has annual expenses of ₹1 lakh, the net rental yield is:
[
\frac{6,00,000 – 1,00,000}{1,00,00,000} \times 100 = 5\%
]
How Current Rental Yield Improves Mortgage Loan Value
Rental yield can influence the value of a mortgage loan in the following ways:
1. Increased Property Valuation
- Higher Rental Yield = Higher Market Value: A property with a higher rental yield typically indicates strong demand for rental space in the area, making it a more valuable asset. If the property generates steady rental income, it can increase its overall market value. Lenders often assess properties that generate regular rental income more favorably, as it shows the potential for the borrower to make mortgage payments.
- Capital Appreciation: Properties with high rental yields may also experience higher rates of capital appreciation over time, further improving the property’s value. Lenders take this into account, potentially offering larger loans.
2. Increased Loan-to-Value (LTV) Ratio
- Lower Risk for Lenders: Properties generating stable rental income pose a lower risk for lenders. If a borrower defaults, the lender can rely on the rental income to recover some of the loan. Because of this reduced risk, lenders may be willing to offer a higher Loan-to-Value (LTV) ratio (e.g., 70%-75%) compared to properties without rental income.
- Higher Loan Amount: A higher LTV ratio translates to a higher loan amount. For example, if a property with no rental income qualifies for a 60% LTV loan, a property with strong rental yield might qualify for 70% or more, allowing you to borrow a larger amount.
3. Improved Repayment Capacity
- Additional Source of Income: For borrowers, the rental income from a property can serve as an additional source of income to make regular loan payments. Lenders view this favorably as it lowers the risk of default.
- Income Documentation: Showing consistent rental income through rent receipts and lease agreements can strengthen the borrower’s loan application, especially if other forms of income are insufficient. It enhances the borrower’s ability to repay the mortgage.
4. Favorable Interest Rates
- Lower Interest Rates for Lower-Risk Properties: Properties with a higher rental yield represent lower risk to lenders. As a result, borrowers may be able to negotiate more favorable interest rates on a Loan Against Property (LAP), reducing the overall cost of borrowing.
- Better Loan Terms: Lenders may also be more willing to offer flexible terms, such as longer repayment periods, reduced processing fees, or lower prepayment penalties, for properties with reliable rental income.
5. Boosts Credibility for Commercial Properties
- Stronger Collateral for Commercial Loans: For commercial properties, rental yield is a critical factor in determining their value. A commercial property (like an office space or retail shop) with established tenants and long-term lease agreements will have a higher valuation. Lenders are more willing to offer larger loan amounts for commercial properties with strong rental yields.
- Mitigating Risk of Default: Commercial properties with consistent tenants and rental income can offset the risk of default. In the event of financial strain on the borrower, the lender can use rental income to mitigate losses.
6. Increased Liquidity
- Easier Sale of Property: Properties with a higher rental yield are easier to sell in the market. If the borrower faces a financial crunch and needs to liquidate the asset, the property is more likely to attract buyers due to its income-generating potential. This makes the property more valuable as collateral for a loan.
- Stronger Asset Portfolio: For real estate investors, a property with strong rental income enhances the overall liquidity of their asset portfolio. Lenders see these assets as more stable and may offer better financing options.
7. Rental Income as Part of EMI Payments
- Using Rental Income for EMI Repayment: Borrowers can use the rental income to cover a significant portion of their Equated Monthly Installments (EMIs). This gives the lender confidence that the borrower has additional cash flow to service the loan, further reducing the risk of non-payment.
- Improved Debt-to-Income Ratio: By including rental income in the calculation, the borrower’s debt-to-income ratio improves, making it easier to qualify for larger loans or better loan terms.
Conclusion:
Current rental yield is a key indicator of a property’s income-generating potential and plays a crucial role in determining its mortgage value. A higher rental yield not only increases the property’s market value but also reduces the lender’s risk, allowing for higher loan amounts, more favorable interest rates, and better loan terms. If your property generates reliable rental income, it can significantly enhance the chances of securing a larger and more affordable Loan Against Property.