One of the most important factors that defines success in property investment, is the ability to accurately calculate the rental yield on each property. An alarming number of investors take the step into property investment without actually taking the time to work out the numbers; they go into it purely because they believe that property is one of the best investment opportunities.
A lot of these people have been lucky because the property market was doing so well but with less certain times ahead for the economy on the whole, such gambles are less likely to pay off. Now is the time to verify the rental yield when considering investments.
Buying property will only be a good investment if the financials stack up to provide a healthy profit. Investors that rush into buying property without calculating the yield put themselves at risk of taking on a bad deal that makes so little profit that it isn’t worth the work, or in some cases, actually leaves them financially worse off!
To avoid this scenario, successful property investors always calculate the projected rental yield and see how much ROI each property will deliver. You could have two properties, both valued at exactly the same price, but one is able to attain a much higher yield than the other due to the area or the demand in that area. This is why it is so important to understand how to calculate the yield to assess which property to buy.
How to calculate gross yield
The gross yield simply provides the annual income that the property will generate.
Example – If the annual rent is £6,000 and the property cost £100,000, the gross yield is 6%.
This does not take costs into account, so is not the most useful type of calculation for investors.
How to calculate net yield
The net yield is a better indicator of whether it is a good deal, as it factors all of the relevant costs into the equation.
Example – If annual rent is £6,000 and there are £1,500 annual costs, profit is £4,500.
With a purchase price of £100,000 this would give a net yield of 4.5%.
- Mortgage payments
- Agent fees
- Landlord insurance
- Ground rent
Another cost to think about is potential voids, where the property could be empty and therefore no rent is being collected. Doing research into the demand for rental properties in that specific area will help to determine whether this cost also needs to be brought into the calculation. For example, if rental properties are taking on average one month to find and place tenants, a month’s rent would be a suitable cost to prepare for.
Calculating Return on Investment
Where landlords are taking out a BTL mortgage for the property, they tend to opt for the ROI calculation, as this works out a bit different to the net yield calculation, as the mortgage payments bring the profits down.
Example – If annual rent is £6,000 and there are £3,000 in costs (incl. mortgage payments), annual profit would be £3,000.
If the landlord takes out a £75,000 and invests £25,000 of their own money, the ROI =
£3,000/£25,000 X 100 = 12%
Therefore, the landlord makes a 12% return on their investment of £25,000.
These are the three main ways that are used to calculate whether a particular property will be a good investment.
What else is required to analyse the deal?
As well as understanding how to calculate the yield from your property, it is also important to get all of the other figures that go into that calculation as accurate as possible. If this is the first property that you are buying, or the first property in a specific area, then you should do some research as part of your deal analysis process.
Researching the rental market
If you are using an estate agent to find your tenants, then they should be able to give you a good idea of what monthly rent the property will be able to command. Of course, if you are using an agent then you will also need to factor the finder’s fee and monthly agent fees into your costs.
If you decide to not use an agent and find and manage the tenancy yourself, before you purchase a property you should research the local rental market. You can use websites such as Rightmove to look at similar properties in that locality to see how much landlords are charging for rent and filling the properties. If there are properties of a similar condition in the same area that are staying on the market for a while, that is an indication that the monthly rent fee is too high, or there just isn’t much demand in that area for renting that type of property.
Area research also includes taking a look at the local amenities and whether they will suit the type of tenant that you are looking to have in your property. For example, a young family would be interested in the quality of local schools, whether there are good transport links for commuting to work etc. Students will want to be in close proximity to their place of study and are likely to want to be closer to supermarkets, bars/pubs and takeaways.
So, it is important that you do the adequate research into the local area to check that it matches the needs of the types of tenants you are looking to rent your property to and that there are enough people looking to rent in that area. Once you have done this research, you then do the sums to check whether the property you are interested in will provide you with the profit margin that makes it worthwhile for you.