Real estate investment generates rental income, and if managed well, it can continue to produce stable profits.
The key to success lies in the properties you operate.
When selecting properties for real estate investment, utilizing the yield gap is highly recommended.
It is a term that frequently appears in real estate investment books and other materials, but since it is not commonly heard, many people may not fully understand it.
So this time, we will explain in detail the yield gap, which is important for selecting properties in real estate investment.
Understand the meaning and essence of the concept, and apply it to your property selection to achieve success in real estate investment.
What Is the Yield Gap in Real Estate Investment?
First of all, what exactly does the yield gap mean?
Let's start by explaining the meaning of the yield gap and how to think about it in the context of rental properties.
What the Yield Gap Means
The yield gap refers to the difference between the investment yield and the long-term interest rate.
It is an indicator for measuring how much profit is generated when investing with borrowed funds from a financial institution.
In real estate investment, the investment amounts are large, so most cases involve taking out a loan from a financial institution.
Therefore, understanding the yield gap is important in order to properly assess how much income can be generated through a loan.
When purchasing a property for real estate investment, the yield of the property tends to attract attention.
However, no matter how high the investment yield is, if the borrowing interest rate is high, profitability will be low.
In order to select a profitable property, it is necessary to understand the difference between the investment yield and the loan interest rate.
How to Calculate the Yield Gap
If you want to know the yield gap of a candidate property, try calculating it yourself.
The yield gap can be calculated using the formula "yield − interest rate."
By calculating the yield gap for each candidate property, you will be able to compare their profitability in numerical terms.
Let's look at a calculation example using the following conditions.
・Property A: yield 6%, interest rate 2%
・Property B: yield 8%, interest rate 5%
【Property A】
Yield 6% − Interest rate 2% = Yield gap 4%
【Property B】
Yield 8% − Interest rate 5% = Yield gap 3%
Looking at yield alone, Property B appears higher and one might expect better profitability.
However, looking at the yield gap, we can see that Property A is 1% higher than Property B.
Taking into account the burden of interest rates, it is easy to determine that Property A offers better profitability than Property B.
The Yield Gap in Rental Properties...What Is the Thinking Behind It?
As explained above, the yield gap makes it possible to measure the profitability of an investment property.
When the yield gap is high, it generally means that the yield is high and the interest rate is low.
Also, there are cases where good profitability is achieved even with a low yield, as long as the interest rate is also low.
Conversely, when the yield gap is low, it indicates a situation where the yield is high but the interest rate is also high.
When the yield is low and the interest rate is high, the yield gap also becomes low, and profitability cannot be expected.
Future cash flow will become tight, making it difficult to continue rental management.
Furthermore, if factors such as rent reductions and rising interest rates overlap, the yield gap will decline even further.
Considering the risks that may arise in the future, selecting a property with a high yield gap is an important point.
What Is the Appropriate Yield Gap?
A property with a high yield gap is attractive for real estate investment, but what level is actually considered appropriate?
Here we present the appropriate values for used properties and new properties as a reference.
Appropriate Value for Used Properties
If you want to invest in real estate using a used property, aim for a yield gap of 3% or more.
Compared to new properties, the purchase price is lower, so the nominal interest rate tends to be higher.
However, the costs for repairs, vacancies, and tenant recruitment tend to be higher than for new properties.
In suburban areas, properties with a nominal yield of 10% exist, but many of them require large-scale repairs or are located in areas with poor occupancy rates.
Therefore, be careful not to focus solely on the yield.
After subtracting all expenses and interest from rental income, look for properties with a yield gap of 3–4% or more as a guideline.
Narrow down candidates to properties with a large yield gap, and check how much cash flow you can obtain.
Appropriate Value for New Properties
For new properties, a yield gap of 3% or more is also the appropriate value.
Compared to used properties, the purchase price is higher, so the nominal yield tends to be lower.
However, since the property is new, annual costs such as repair expenses tend to be lower — this is a difference from used properties.
That said, there is a risk of future rent declines, so be aware that operation may not achieve the initially expected net yield.
In terms of financing, low-interest-rate loans are often available, so even properties with a low yield may have potential for a high yield gap.
As with used properties, narrow down candidates to those with a yield gap of 3% or more, check the cash flow, and then select the property to purchase.
Points to Note About the Yield Gap
While the yield gap is a useful indicator for selecting investment properties, there are important points to keep in mind when using it.
Relying solely on this indicator when making investment decisions can be dangerous, as it may lead to irreversible problems later on.
Here are the key points to be aware of when utilizing the yield gap.
Is It Calculated Using the Net Yield?
The yield gap is derived by subtracting the interest rate from the investment yield, and it is preferable to use the net yield for this calculation.
There are two types of yields in real estate investment: the nominal yield and the net yield.
The nominal yield is a figure that superficially represents income, showing how much rental income can be secured relative to the property price.
Since various expenses such as property maintenance costs are not taken into account here, the nominal yield differs from actual income.
On the other hand, the net yield is calculated taking into account annual expenses and purchase-related costs, allowing you to understand the more accurate yield of the property.
The yield figures listed in real estate advertisements are basically nominal yield figures.
Even if the yield gap appears high based on the nominal yield, there is no point if the yield gap drops significantly when calculated using the net yield.
Therefore, the yield gap must be calculated using the net yield.
Incidentally, the net yield can be calculated using the formula "(Annual rental income − Annual expenses) ÷ (Tax-included property price + Purchase-related expenses) × 100."
Using the following conditions, we calculated the difference between the nominal and net yields, as well as the yield gap.
Nominal yield: 6.4%
・Total investment (expenses 5%): ¥52.5 million
・Estimated annual income at full occupancy: ¥3.2 million
・Actual annual income (vacancy rate 20%): ¥2.56 million
・Estimated annual expenses (expense ratio 20%): ¥512,000
・Operating income (actual annual income − estimated annual expenses): ¥2.048 million
・Loan interest rate: 2%
【Nominal yield case】
Property purchase price ¥50 million − Annual income ¥3.2 million × 100 = Nominal yield 6.4%
Nominal yield 6.4% − Interest rate 2% = Yield gap 4.4%
【Net yield case】
Operating income ¥2.048 million ÷ Total investment ¥52.5 million × 100 = Net yield 3.9%
Net yield 3.9% − Interest rate 2% = Yield gap 1.9%
When purchasing a property under the above conditions, the nominal yield is 6.4%.
However, when taking into account various expenses and vacancy risk, the net yield drops to 3.9%, nearly half.
This significantly changes the actual yield gap, so please take note.
The Loan Term Is Not Considered
Also note that the yield gap calculation does not take the loan term into account.
The annual loan repayment amount varies depending on the loan term, which in turn affects the net income.
Since annual income changes depending on the loan term, making investment decisions based solely on the yield gap without considering the term is risky.
Therefore, let's incorporate the concept of the loan term when calculating the yield gap.
The yield gap incorporating the concept of the loan term can be calculated using the formula "Net yield of investment property − K%."
"K (%)" is called the loan constant and can be calculated as "Annual loan repayment (interest + principal) ÷ Total outstanding loan balance."
Let's calculate the yield gap incorporating the loan term concept under the following conditions.
・Loan amount: ¥50 million
・Annual repayment: 【10-year term】¥5.52 million, 【30-year term】¥2.22 million
・Net yield: 3.9%
【10-year term】
Annual repayment ¥5.52 million ÷ ¥50 million = 11.4% (K%)
3.9% − 11.4% = −7.5%
【30-year term】
Annual repayment ¥2.22 million ÷ ¥50 million = 4.4% (K%)
3.9% − 4.4% = −0.5%
In both cases, the yield gap turned negative, indicating that borrowing may result in a loss.
In this case, it is necessary to either increase the occupancy rate or reduce expenses.
Since the net yield tends to decline over time, if the interest rate remains constant, K% will not change, and there is also a risk that the profit/loss gap will widen.
As a result, it can be determined that continuing to hold a property under the above conditions carries the risk of a negative cash flow.
Even if the yield gap appears high based on the net yield, failing to consider the loan term may cause you to invest without noticing the risk of deteriorating cash flow, so please be careful.
The Yield Gap in Japan
How has the yield gap trended in Japan?
Let's look at past trends in the yield gap, recent movements, and future projections.
Historical Yield Gap Trends
In the early 1990s, Japan was in the prosperous bubble era.
With the economy booming, many people — especially business owners — were spending freely, and real estate transactions were active, causing property prices to rise in line with demand.
At the same time, however, real estate yields were low, so the yield gap during the bubble era was negative.
At that time, financial institution interest rates were 6–8%, while the nominal yield on properties in urban areas such as Tokyo was as low as around 2–4%, so the yield gap tended to be low.
While real estate prices rise in line with demand, rents do not change drastically.
In other words, during the bubble era, it was difficult to earn through rental income, so the dominant style was to profit from the sale of real estate.
Recent Yield Gap Trends
The bubble era collapsed in 1991.
As people who had been spending freely stopped borrowing from financial institutions, interest rates fell dramatically.
Rates that were around 6–8% during the bubble era dropped to 2–4%.
At the same time, real estate stopped selling and prices plummeted.
However, yields were on an upward trend.
Even if real estate prices fell, rents would not be cut in half.
As a result of being able to purchase properties cheaply due to falling real estate prices, yields rose, and with financial institutions' interest rates also declining, the yield gap has tended to be high.
Since rental income remains unchanged while properties can be acquired cheaply, real estate investment in Japan after the bubble collapse shifted toward a style of earning through rental income.
Predicting the Future Yield Gap!
Since the bubble collapse, the yield gap has been in positive territory, making it relatively easy to profit from real estate investment even with debt.
However, you may also be wondering how the yield gap will trend going forward.
It is also important to project the future yield gap based on three factors: rent, financing, and property prices.
・Rent
First, regarding rent, there is a possibility that it will decline going forward.
The reason is that as rental pricing becomes more transparent, competition is expected to intensify.
The real estate industry still has many opaque aspects, and the current situation requires choosing properties with limited information.
However, with the spread of the internet, opaque areas are gradually becoming clearer, shifting to an environment where people can choose properties with access to more information.
If rental prices become transparent across many properties, competition will intensify accordingly.
In fact, the intensification of competition is already visible through the increase in properties advertising zero brokerage fees, zero security deposits, and zero key money.
Along with this, there is a possibility that rents will decline.
・Interest Rates
Interest rates are expected to rise going forward.
In the current ultra-low interest rate environment, it is sometimes possible to obtain financing at rates in the 1% range.
Since this situation has continued for a long time, it is unlikely that interest rates will fall further.
That being the case, it is thought that they will gradually rise going forward.
・Real Estate Prices
Real estate prices may decline.
As financial institutions tend to tighten lending, the number of real estate buyers has been decreasing.
As demand for real estate falls, real estate prices will also fall.
A fall in prices means there is potential for yields to rise.
If you can purchase real estate while interest rates are still low, you can expect the yield gap to be high as well.
Don't Judge Property Selection by Yield Gap Alone!
The yield gap is one of the important factors in real estate investment.
However, it is merely an indicator and is not a silver bullet.
You cannot definitively say that "a large yield gap value guarantees success in real estate investment," so you need to consider from other angles what is necessary to generate profit.
One such factor is "cash flow."
Cash flow refers to the movement of money.
In real estate investment, what matters is how much cash flow "remains on hand."
The reasons why it is important are as follows.
Can Be Used for Loan Repayments
Having cash on hand provides peace of mind in the management of real estate investment.
In real estate investment, income decreases when vacancies occur.
However, loan repayments continue, so you must keep making repayments even when income is reduced.
In such cases, the investor covers repayments with their own funds, but this is difficult if there is no cash on hand.
There may also be cases where sudden equipment replacement or repairs become necessary.
It is necessary to keep cash on hand so that you can respond promptly even in urgent situations.
Creates Financial Breathing Room
Having ample cash flow enriches your life.
In real estate management, expenses that arise are covered by the profits earned from investment, but when cash flow is tight, income from your main job or savings must be used to make up the difference, reducing living expenses.
If your quality of life declines, your mental state will also suffer, making it difficult to continue real estate investment.
You need to continue operating in a way that does not require dipping into living expenses.
Significant Benefits When Selling
When selling a property you own, properties with higher cash flow profits tend to receive higher appraisal values.
This is because they are judged to provide stable income.
If you are considering selling a property in the future, it is thought that maintaining a high cash flow state before selling will yield greater profits at the time of sale.
The cash flow formula can be expressed as "Rental income − Necessary expenses = Cash flow."
Necessary expenses refer to costs required for operation, such as property management fees, repair costs, loan repayments, property taxes, and advertising costs.
Additionally, taxes such as residence tax and income tax must all be deducted.
Therefore, even if you own a property with a monthly rent of ¥100,000 and a monthly loan repayment of ¥90,000, the cash flow will not be +¥10,000, so please be careful.
Running costs and taxes arise, so there is a possibility that the balance will go negative.
Consider purchasing a property by combining both the yield gap and cash flow.
Property Selection in Real Estate Investment...There Are Many Key Points to Cover!
Property selection in real estate investment has a major impact on income and expenditure, so careful checking is necessary.
While it is important to select properties from the perspective of yield gap and cash flow, beginners in real estate investment may find this difficult.
In such cases, start managing your investment while receiving support from a real estate company.
Support from someone who understands investment provides peace of mind, but ultimately you yourself must make the final decision on the property.
In order to invest without regrets and achieve success, we will explain the key points to keep in mind when selecting a property.
Check the Property Facilities
When a property is well-equipped with facilities, many people find it attractive and consider "wanting to move in."
This is effective in reducing vacancy risk.
Package delivery lockers and a well-established internet environment are becoming standard features.
Properties with well-equipped security features such as auto-locks, video intercoms, security cameras, and home security systems are in high demand from households with children and women.
To differentiate from other properties, options such as concierge services, fitness gyms, and rooftop facilities like sky gardens can be considered.
However, adopting luxurious facilities will also require maintenance, generating costs for repairs and replacements.
It is important to carefully assess whether the cost-effectiveness can be achieved.
Check the Property's Surroundings
When selecting a property, also check the surrounding environment.
Basically, the key question is whether facilities necessary for daily life are nearby.
If supermarkets, convenience stores, drugstores, and restaurants where you can shop and eat are within walking distance, they are convenient to visit easily.
Also, having a bank and hospital nearby provides peace of mind.
However, this is meaningless unless it matches your target demographic.
For single-person households, having a convenience store nearby is sufficient.
For family-oriented properties, having a supermarket and drugstore as well as parks, nurseries, and schools nearby adds convenience, making it attractive to potential tenants.
First, narrow down your target demographic before starting your property search.
Check the Age of the Building
Checking the age of the building is also important when selecting a property.
There are cases where used yield-gap properties are sold at unusually low prices.
Be aware that these may be older buildings.
Older buildings tend to have many deteriorated parts and will require repairs in order to operate them.
Rather than just fixing broken areas, replacing them with new equipment tends to attract more tenants.
If significant costs are incurred before operation begins, it will also take time to recoup them.
Check the age of the building and thoroughly assess the condition of the property before making your decision.
Location Selection Is Key in Real Estate Investment! What Are the Target Areas?
In real estate investment, the area where a property is located affects income and expenditure.
It is difficult to reduce vacancy risk unless the area attracts a large number of people.
If you are uncertain about area selection, refer to the following when choosing a property.
Areas That Attract Single Residents Are Target Locations
If you are considering real estate investment for single residents such as studio apartments, areas that attract single residents are ideal targets.
However, targeting specifically students such as university or vocational school students carries the risk of failure.
Properties within walking distance of a university are convenient to commute to and tend to attract tenants.
However, the possibility of a school relocating is not zero.
If it relocates, the student population disappears and the number of tenants will also decline.
Rather than limiting yourself to areas focused solely on students, choosing properties aimed at a wider range of single residents will lead to greater success.
For example, in Tokyo, properties in areas accessible within 30 minutes to terminal stations such as Tokyo Station and Shinjuku Station tend to be in high demand.
Choosing properties with easy access to urban areas for commuting and studying will allow you to operate with a reduced vacancy risk.
Top-Ranked "Most Desirable Neighborhoods" Are Target Locations
If you want to think from the tenant's perspective, referring to "most desirable neighborhood rankings" is also recommended.
Surveys conducted by major rental websites allow you to instantly see which areas are attracting attention from many people.
Rankings also reveal the reasons for each area's popularity, making them extremely useful as reference material.
Rankings vary in format by site, with some divided by region such as the Greater Tokyo Area and Kansai Area, as well as rankings tailored to specific needs such as "most desirable areas to rent" and "most desirable areas to purchase."
Utilizing these when selecting a property will help you find properties that better match demand.
Disaster Risk Considerations Are Key in Area Selection
Typhoons, heavy rain, earthquakes — disasters can occur at any time.
While much is unpredictable, many people searching for properties conduct "property searches with low disaster risk."
Options include purchasing real estate that meets the new earthquake resistance standards or purchasing properties with high seismic performance grades, but checking hazard maps must not be overlooked.
Hazard maps show what types of disaster risks exist in the area where you are considering purchasing a property.
Flood hazard maps allow you to check projected inundation zones.
In addition, you can check for risks of landslides and liquefaction, helping you understand potential dangers in an emergency.
Hazard maps can be checked on the "Hazard Map Portal Site" operated by the Ministry of Land, Infrastructure, Transport and Tourism, so check in advance whether the area where you want to purchase a property is in a safe location.
If the area is problem-free, it will also help reduce repair costs caused by disasters.
Areas With Growing Populations Are Target Locations
A large population ensures stable rental demand.
No matter how attractive a property you prepare, if there are few people, residents won't gather and vacancies cannot be filled.
Therefore, population must also be considered when selecting investment properties.
For example, in Fukuoka City, the young population aged 15 to 29 is projected to increase through 2035.
Watching such population trends and identifying the optimal area is also a key to success in real estate investment.
Areas With Easy Access to the City Center Are Target Locations
Properties in areas close to train stations are expensive, and even if you know demand is high, some people may find it difficult to invest because of the large capital required for purchase.
However, there are many properties outside of the Tokyo city center that are still easy to profit from.
For example, in Kisarazu City, Chiba Prefecture, express buses via the Aqua-Line operate daily, making it easy to access the city center.
In Kanagawa Prefecture, using rapid or limited express trains allows access to Tokyo within 30 minutes from certain stations.
Both Chiba and Kanagawa Prefectures have a large number of leisure spots and shopping facilities, making them easy places to live.
In addition, with easy access to the Tokyo city center, they are also convenient for commuting and studying, resulting in high demand.
Furthermore, in recent years, remote work has become widespread due to the impact of the novel coronavirus.
People are now able to continue working without living near their workplace, and the number of people relocating to regional areas outside the city center has increased.
Since 2020, inflows to Tokyo have declined significantly.
On the other hand, outflows from Tokyo, which were 601,000 between 2018 and the first half of 2019, increased by 40,000 to 641,000 between 2020 and the first half of 2021.
According to a survey by the Development Bank of Japan, destinations for people leaving Tokyo after COVID include Kanagawa, Saitama, Chiba, Ibaraki, Tochigi, Shizuoka, and Nagano prefectures, all of which are increasing.
All of these are areas with easy access to Tokyo.
Even with the advancement of remote work, if a company's headquarters is in the city center, there will be cases where employees commute there periodically.
In such cases, living in an area with easy access to the city center is more convenient and easier to commute from.
If you are looking for properties outside the city center, try searching for properties that have easy access to the city center and are also situated in a good surrounding environment.
Points to Note When Selecting a Property
Property selection is indispensable for real estate investment.
However, you must make judgments comprehensively taking into account all aspects — yield gap, cash flow, location, surrounding environment, and more — to select the optimal property.
For beginners in real estate investment, there are limits to doing this alone.
In that case, please proceed with your investment while relying on a real estate company.
Since they have extensive knowledge about investment, you can consult with them to make the optimal property selection.
They will introduce attractive properties such as those with "a high yield gap," "easy to purchase because of low loan interest rates," and "priced low despite a good location."
However, depending on the sales representative or real estate company, there are cases where purchases are being pushed only with the company's interests in mind, so caution is necessary.
Regarding the yield gap, there is also the possibility that it is being presented attractively by calculating it using the nominal yield.
Of course, not all real estate companies do this.
In order to avoid falling for unscrupulous companies, choosing a trustworthy company is also important in real estate investment.
Summary
If you make a mistake in selecting the property to operate, you will not be able to achieve the profits you hoped for and may come to regret having started real estate investment.
Utilizing the yield gap is essential in property selection.
However, if you focus solely on the yield gap, you will not be able to make the optimal property selection.
Proceed with your property selection to achieve profit while also considering cash flow, surrounding environment, and property area as mentioned above.
And when selecting a property, do not rely solely on real estate companies — conduct your own investigation of the building and then start your real estate investment.
Frequently Asked Questions About the Yield Gap
Q1. What is the benchmark for the yield gap?
Generally, a yield gap of 1.5–2% or more is considered a benchmark for investment decisions. However, the location and age of the property must also be taken into consideration.
Q2. Is a high yield gap safe?
Even if the yield gap is high, actual profitability can be low if vacancy risk and repair costs are not taken into account. A comprehensive judgment is important.
Q3. What is the relationship between the nominal yield and the yield gap?
The yield gap is derived by subtracting the borrowing interest rate from the nominal yield. For a more accurate judgment, use the net yield (NOI yield).
