Rent divided by price is the number every listing quotes and no owner receives. Take the five deductions out and Property P's 8.00% becomes 4.264% - and the two halves of the return turn out to be far less connected than they sound.
12 min read · Level 2
The gross-to-net gap is usually presented as a beginner's oversight, and I think that undersells what is happening. Gross yield persists because it is the only figure in the transaction that both parties can compute from public information, which makes it the natural currency of a conversation between a seller who knows the deduction list and a buyer who does not. That asymmetry is the whole trade. A seller has owned the building for years; they know exactly how often it empties, what the roof is going to cost and which month the service charge lands. A buyer has a listing. So the number everybody agrees to discuss is precisely the one that contains none of the information the seller holds - and the reason it feels like a shared standard rather than an advantage is that nobody involved is being dishonest. The seller is not hiding the vacancy history; nobody asked. What follows is not cynicism but a habit: the deduction list is the diligence, and the list you cannot fill in from documents is a list of questions rather than a list of estimates. A buyer who arrives with most of the list already computed and one line they cannot source has found the thing worth negotiating about. A buyer who arrives with a percentage has found nothing and will pay for it slowly, over about four years, one bill at a time.
Property pays you twice: rent while you hold it, and whatever the building is worth when you sell. The first is the half everybody quotes and almost nobody computes correctly.
Property P: price 300,000, gross annual rent 24,000.
Gross rental yield 24,000 / 300,000 = 8.00%
That figure is on the listing. Now take out the five things that happen to every rented building.
Gross rent 24,000.00 Less vacancy and arrears, 8.0% of gross -1,920.00 --------------------------------------------------------------- Collected rent 22,080.00 Less management, 10.0% of collected rent -2,208.00 Less maintenance and repairs, 1.0% of price -3,000.00 Less insurance -1,200.00 Less local property tax -2,880.00 --------------------------------------------------------------- Net operating income 12,792.00
Net rental yield 12,792 / 300,000 = 4.264%
The five deductions total 11,208, and the yield fell by 3.736 percentage points. What survives is 53.3% of what was advertised. Nothing unusual has happened here and no assumption is aggressive: a unit empty for one month in twelve is a vacancy rate of 8.3%, maintenance at 1.0% of value a year is a conventional allowance for a building that is not new, and every one of the other three is a bill somebody sends you.
That 4.264% is also the property's capitalisation rate, because a capitalisation rate is net operating income divided by price and that is exactly what was just computed. The two names describe one number from two directions - the buyer's income return, and the market's required return - which is why lesson three can use it as a valuation lens.
One deduction is deliberately absent. Financing is not in the list, because net operating income describes the building and not the buyer. A mortgage is a fact about how you paid, not about what the asset produces, and mixing them means two people buying the same building compute two different yields for it. Financing enters in lesson five, where it belongs.
Then the second half: what the building is worth later. There is no cash flow attached to it, nothing is received until a sale, and unlike the rent it is not contracted with anybody.
Because the two halves of the return are much less connected than the phrase "property prices track rents" suggests, and a holder who assumes they move together will misread every year they hold.
Take Property P through two different years. In both, rent rises 4.0%. The only difference is the price.
Year A rent +4.0%, price +9.0% to 327,000 Income received 12,792 Change in value +27,000 Total on 300,000 13.264%
Year B rent +4.0%, price unchanged at 300,000 Income received 12,792 Change in value 0 Total on 300,000 4.264%
Identical buildings, identical tenants, identical rent increase, and a nine percentage point difference in the year's outcome. The income half did exactly the same thing in both. Everything that separated them happened in a number nobody paid and nobody received.
And the two years leave you somewhere different for the year after, because the relationship between the rent and the price has changed. Next year's net operating income in both cases is 12,792 x 1.04 = 13,303.68.
After year A 13,303.68 / 327,000 = 4.068% After year B 13,303.68 / 300,000 = 4.435%
The building that rose is now a lower-yielding asset than the one that did not, on the same rent. That is what a compressing capitalisation rate means, and it is the mechanism behind most of the strong periods this class has had: prices rising faster than rents, which is the same event as buyers accepting a lower income return.
Which matters because it cannot continue indefinitely and it does not have to reverse quickly either. A holder who bought into a period of compression and attributes the result to the rent has learned the wrong lesson from a correct outcome.
One more property of the income half worth naming. Rent is contracted. A tenant on a lease owes a stated amount on stated dates, and that obligation exists whether or not the building's value moved. It is not as certain as a bond's coupon - a tenant can leave, stop paying or go under, which is what the 8.0% vacancy and arrears allowance is for - but it is far more predictable than the price leg, and it is the reason this class is described as income-producing rather than as a pure appreciation play. Compare that with a commodity, which produces no income at all, or with a share, whose dividend is declared at a board's discretion each time.
Educational, not personalised financial advice. Nothing in the Investor Academy is a recommendation to buy, sell or hold anything — what is right for you depends on your own circumstances and the rules where you live.
The gap between gross and net is not a quirk of Property P. It is the whole difficulty of the class, and it gets wider in exactly the properties that look most attractive on the listing.
Property Q: price 180,000, gross rent 18,000.
Gross rental yield 18,000 / 180,000 = 10.00%
A full two percentage points better than Property P's 8.00%, at a much lower entry price. Now run the same deductions, with the figures this building actually carries - an older block in a weaker letting market, with a sixth line Property P does not have at all, a service charge.
Gross rent 18,000.00 Less vacancy and arrears, 15.0% of gross -2,700.00 --------------------------------------------------------------- Collected rent 15,300.00 Less management, 10.0% of collected rent -1,530.00 Less maintenance and repairs, 1.8% of price -3,240.00 Less insurance -1,400.00 Less local property tax -2,340.00 Less service charge -1,800.00 --------------------------------------------------------------- Net operating income 4,990.00
Net rental yield 4,990 / 180,000 = 2.772%
Read the two lines together. On gross yield, Q is 1.25 times P. On net yield, P is 1.538 times Q. The ranking does not narrow, it reverses - and it reverses because the deductions are not a fixed percentage of rent. They are driven by the building and its market: a weaker location empties more often, an older block costs more to keep standing, and a service charge is a bill that arrives whether or not anyone is living there.
This is why gross yield is not merely imprecise but actively misleading. It is systematically most flattering to the properties with the worst underlying economics, because a high gross yield usually means a low price, and a low price usually means something. The listing that looks like a bargain is the one where the deduction list matters most, and it is the one where the deduction list is least likely to be published.
The arithmetic took about ten minutes. The difference it revealed - 4.264% against 2.772%, on a decision involving six figures - is the largest return on effort available anywhere in this subject.
Quoting rent divided by price and calling it a yield. It is the single most common error in this asset class and it overstated Property P's income return by 3.736 percentage points, or by a factor of 1.876. Every deduction in the list is a real payment made by real owners every year.
Using a fixed rule of thumb for costs. "Take off a quarter for expenses" would have given Property Q a net yield of 7.50% against its actual 2.772%. Costs are a property of the building and its market, not a percentage that travels.
Omitting vacancy because the unit is currently let. Every tenancy ends. A unit empty one month in twelve is an 8.3% vacancy rate, and a letting market that turns over faster than that costs more, not less, because each re-let carries a void period and an agent's fee.
Counting the mortgage payment as an operating cost. Net operating income describes the building. Financing describes the buyer. Mixing them produces a figure that cannot be compared with any other property, which is exactly the comparison the number exists to make.
Assuming rent growth and price growth are the same event. Year A and Year B above had identical rent and a nine point difference in outcome. Attributing a strong year to the rent when it came from a compressing capitalisation rate is how a holder builds a forecast on the one thing that did not happen.
Subtract a vacancy and arrears allowance before anything else, and set it from the letting market rather than from the current tenant. One void month in twelve is 8.3%; a building whose tenants stay four years and a building whose tenants stay eleven months carry very different figures, and the second one also pays a re-letting fee each time.
Management as a percentage of collected rent, maintenance as a percentage of value, insurance and property tax as the amounts actually billed, and any service charge or ground rent in full. Separate lines are what let you check each one against a document. A single lumped allowance is a guess wearing a total's clothes.
Deliberately exclude the mortgage. The output is a statement about the building that any buyer can compare with any other building, and it is the numerator of the capitalisation rate lesson three uses. Financing is added afterwards, on top, as a separate question about you.
For Property P that is 8.00% and 4.264%; for Property Q it is 10.00% and 2.772%. Keeping both is not redundancy - the size of the gap is itself the finding, and a building where the gap is unusually wide is telling you something about its condition, its location or its charges that the net figure alone does not.
Record what you actually collected and what you actually spent, and record the change in value separately. At the end of a good year you will be able to say which half produced it. Holders who keep one combined number invariably attribute a compressing capitalisation rate to their own judgement about the rent.
On every property you appraise, before comparing any two properties on yield, and once a year on anything you already own, using the amounts actually received and actually paid rather than the ones you assumed at purchase.
Do not use a net yield to compare a direct property against a listed trust without adjusting for the trust's own debt and management costs, and do not treat net operating income as cash in your pocket - it is the building's income before financing, before capital spending and before tax.
Shorthands for property costs circulate widely - take off half, take off a quarter, assume the rent covers the mortgage - and each of them was probably accurate for one type of building in one market at one time. They persist because they are memorable and because they are never tested against the specific building in front of the person using them. Applied to Property Q, a quarter deduction gives 7.50% against an actual 2.772%; applied to Property P it gives 6.00% against 4.264%. The shorthand was wrong in the same direction both times and wrong by very different amounts, which is what makes it worse than useless: it produces a number confident enough to act on and unreliable enough to be dangerous.
A cost percentage that travels between buildings is not an estimate, it is a guess with a reputation. Build the list line by line for the building you are actually buying.
Periods in which property performs unusually well are frequently periods in which capitalisation rates fell - prices rose faster than rents, so buyers ended up accepting a lower income return for the same building. Owners who lived through such a period tend to describe it in terms of the rental market, because rent is the part they interacted with daily, and the part that actually moved is one they never transacted in. The consequence shows up later, when the same person underwrites a new purchase assuming the pattern continues and prices the deal on the appreciation half rather than on the income half. Separating the two legs each year, in writing, is what makes the distinction visible while it is happening rather than afterwards.
Record the income leg and the price leg separately every year you own a property. A combined figure lets you credit the rent for something the capitalisation rate did.
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