Shophouse Rental Yields: How to Work Out Gross and Net Yield

Yield tells you how much income a shophouse produces for the money you put in. It is one of the first numbers investors ask for, and one of the easiest to get wrong, because the figure depends on which costs you count. Here is how to work out gross and net yield yourself, and what to check before you trust either number.

Gross yield: the quick comparison

Gross yield = annual rent ÷ purchase price × 100. It ignores all costs, so it is useful for a first comparison between properties but says little about what you will actually keep. Use the rent before GST, because any GST a registered landlord collects on rent is not the landlord's income.

Net yield: what you actually keep

Net yield = (annual rent − yearly running costs) ÷ purchase price × 100. Investors often leave out the loan, so that properties can be compared regardless of how each buyer finances the purchase. These are the running costs to count:

• ◆Property tax: commercial property is taxed at 10% of its Annual Value, and lower owner-occupier rates do not apply to non-residential property.
• ◆Vacancy: an allowance for the months between tenants, when there is no rent coming in.
• ◆Insurance, repairs and upkeep: older conserved buildings can need more care, so ask for past repair records.
• ◆Letting costs: agent commission, legal fees and lease stamp duty, averaged over the length of the lease.
• ◆Management fees, if you pay someone to look after the property.

Annual Value is IRAS's estimate of what the property could rent for in a year, not the rent you actually receive. It can be higher or lower than your real rent, so look up the actual figure instead of assuming the two match.

A worked example

The numbers below are made up and kept simple to show the arithmetic. They are not a real shophouse, a market price or a typical yield.

Measure against your total cost, not just the price

The price is not all you pay, so a more honest yield divides net income by your total cost. Three items matter most:

• ◆Buyer's Stamp Duty: on S$1,000,000 of non-residential property, the current rates give S$24,600.
• ◆GST: if the seller is GST-registered, GST at 9% generally applies to the sale of commercial property. A GST-registered buyer using the property for taxable business can generally claim it back, subject to IRAS's conditions. If you cannot, it is a real cost.
• ◆Legal fees and any renovation needed before the property can be let.

In our example, adding the S$24,600 of stamp duty and an assumed S$5,400 of other costs brings the total to S$1,030,000, and net yield falls to about 2.6%. If S$90,000 of GST could not be claimed back as well, the total would be S$1,120,000 and net yield about 2.4%.

Tax and GST points that change the result

• ◆Yield is usually quoted before income tax, but rental income is taxable. The points below come from IRAS's guidance for individuals. If you buy through a company or trust, ask your adviser.
• ◆Non-residential rent: you can only claim actual expenses, not the 15% deemed expense available on residential property, so keep your records.
• ◆Generally claimable: mortgage interest on the loan used to buy the property, property tax, fire insurance, and repairs that restore the property to its original state. Costs during a vacancy can also be claimed if you made reasonable efforts to find a new tenant.
• ◆Generally not claimable: loan principal, initial repairs, renovations and improvements. Letting costs for a lease longer than 3 years, excluding renewal options, are also not deductible.
• ◆A shophouse with both uses: where the residential and commercial parts are distinct and demarcated, the residential part uses residential property tax rates and the commercial part stays at 10%. Only the non-residential part is subject to GST.

Before you trust a yield figure

• ◆Ask for the signed tenancy agreement. An asking rent or estimated rent is not the same as rent actually being paid.
• ◆Check the lease: when it ends, any rent-free periods or stepped rents, and who pays for what.
• ◆Check the tenant's use against the approved use. If the use is not approved, the rent may not last.
• ◆Compare the rent with others nearby. URA publishes office and retail rental figures by street, from contracts submitted to IRAS. They are not specific to shophouses and do not cover every street, so treat them as a rough guide.
• ◆Ask whether the rent can be sustained. A high yield can simply reflect a rent that is above the market, or a short lease.

Yield is only part of the return

Yield measures income, not the change in the property's value. A low-yield freehold shophouse and a higher-yield 99-year shophouse can suit different investors, so weigh yield together with tenure, approved use, location and condition. Your mortgage also affects your actual cash flow, so run a separate version of the sums with your loan once a bank has given you its terms.