The two most important metrics while measuring the value of a property are the rental yield & the rental share of income in an area. Here are examples of both these metrics across three key neighborhoods in Manhattan, New York

The rental yield is the most important metric in calculating the valuation of a property. Think of the rent as the profit of a business. The value of the house is how much you are paying to get the cash flow. This is similar to the P/E ratio of the business. The higher the rental yield, the better an investment could be.

Rental share of income is another critical piece of the puzzle. Rents come out of your wages (i.e. you can't pay more than you earn). If a particular area is paying less in rent relative to the salaries, that means there is a higher chance of rents increasing because there is more room to grow as a percentage of your wages. Therefore, as rents increase your property value will go up.

Here is an example to make it clear:

  • On Day 1:

    • Rent= $100 & Property value = $1000 so the rental yield = 10%

    • Income=$500, therefore rental share of income =20% ($100/$500)

  • On Day 365:

    • People feel that they can pay more for rent as a percentage of income, therefore they increase the rent to $150 & therefore the rent's share of income = 30% ($150/500)

    • If you assume the same yields of 10%, then the property value increases to $1500 because $150 in Rent /10% = $1500

Both these metrics go hand in hand. A high rental yield implies a good return on your investment but if people in the area are paying through the nose to make rent as a percentage of income, then your growth will be less. Similarly, just going by rental yield may not give a complete picture. For example, distressed areas like Flint & Detroit may show up high on the list but may not have much growth in the future because the wages/rental income will decline in the future.

When you think of rental yield, think value. When you think of rental share of income, think of potential for future growth.