When investing in property the most important thing at play is your ability to calculate rental yield. Whether you are new to investing in property or a landlord with a number of properties under your belt, it doesn't matter - calculating the rental return on your properties is something that you cannot overlook.
- What Is Rental Yield?
- Why Rental Yield Matters
- Capital Growth and BMV Deals
- How To Work Out Rental Yield
- An Example Calculation
- What Is A Good Rental Yield?
- Costs Your Rental Income Needs To Cover
- What Makes A Good Buy To Let Investment?
- Price, Yield and Growth. Finding the Right Balance
- Putting It All Together
What Is Rental Yield?
Rental yield is the return a property investor is likely to achieve on a property through rent. It is a percentage figure, calculated by taking the yearly rental income of a property and dividing it by the total amount that has been invested in that property.
Why Rental Yield Matters
When it comes to investing in property, achieving a good rental return is of paramount importance.
If your income falls short of your expenditure then you lose money. If you are breaking even then you are not making any money. And, if your income doesn't leave room for contingencies then a broken boiler or a problem with a roof can put you seriously in the red.
"Long-term sustainability" should be the watchwords of any buy to let investment.
Capital Growth and BMV Deals
When investors focus too much on other factors in property (down-playing the importance of a good rental yield in their calculations), that's when they run into trouble.
Capital growth, for instance, is an important part of planning a property portfolio. Choosing the best area to invest in - one that promises a rise in house prices - will make you good money in the long run.
Similarly, being able to spot below market deals and snap up property for less than it's potential worth is worthwhile for obvious reasons.
But, if you focus on just on either capital growth or on finding BMV deals without properly considering rental yield, then you risk losing all of the gains you might have had and more.
Because, making sure that the property pays for itself month-by-month is far more important than securing a discount when you bought it, or some theoretical profit when you sell.
How To Work Out Rental Yield
There are a number of different methods by which investors work out rental yield for an investment property. The simplest way is to take the yearly rental income and divide that by the purchase price + costs. Then you take that figure and multiply it by 100 to get a percentage.
Rental Return: An Example Calculation
So as a theoretical yield example:
If we take a buy to let property that can be rented out at £500 per month, this will give a yearly rental income of £6,000.
Let's say that the property was bought for £70,000 and needed a further £5,000 spent on refurbishments.
In this example, the calculation for rental return would look like this:
...giving the property in question a rental yield of 8%.
What Is A Good Rental Yield?
In our experience, a good rental yield for buy to let property is 8% or more. Anything under that and there might not be enough cash-flow in the property to cover running costs, mortgage payments and those unforeseen, expensive problems that sometimes crop up when you invest in property.
So when you are trying to find the best area in which to invest you need to be careful that you choose somewhere where the rental returns make sense.
Areas that have a fantastic rental demand or capital growth can be very tempting. Similarly below market value property can often look like a good deal. But, if the rental return is only, say 5%, then month-by-month your income is unlikely to even cover the mortgage payments.
Costs Your Rental Income Needs To Cover
In order to be sustainable over the long term your rental income needs to cover the running costs of the property and - I can't stress this enough - you also need a contingency budget.
You need to expect the unexpected and be prepared for your costs to increase without warning.
For instance, interest rates on mortgages are at a historical low at the moment. When the cost of lending returns to more normal levels landlords left holding property with low rental yields (under 8%) could find themselves in a lot of trouble.
And mortgage payments are only one cost in many. From your rental return, you will also need to cover management fees, buy-to-let landlord insurance and maintenance costs, all of which can fluctuate.
Costs can go down of course but you need to plan for when they inevitably go up. A house has a boiler and a roof, both of which can suddenly need replacing without warning and at significant expense.
What Makes A Good Buy To Let Investment?
Whilst a good rental return is extremely important when you are choosing a buy to let investment property there are of course other elements that you will need to balance out as an investor. In other words, although it is of paramount importance that the rental yield is high enough to cover costs, that doesn't mean that you should be aiming for the highest possible return.
For example, there are areas of Manchester where you can see rental yields of over 10% for single let properties. Does this fact make these properties fantastic investment opportunities?
These houses are £40k terraces that have little chance of growing in value and where the tenants are unreliable and difficult to deal with. Also, properties like this are difficult to sell and with any investment, an exit strategy is an essential thing to plan.
Price, Yield and Growth
The best investment properties strike a balance between a lot of different factors. As in life, the trick is to find a happy medium.
Yes, you need a property that has a rental yield of around 8%. But, you also need to have a good location, good capital growth and decent tenant demand.
There are seven essential elements to investing in property that need to be considered before you take action. These include tenant demand, capital growth, achievable discounts and your exit strategy.
For further reading, you can see our complete property investment checklist, here or this article on calculating rental yields in London.
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