When deciding whether to become a landlord or expand your property portfolio as an existing landlord, choosing the right property is key. Whilst there are factors around the local market, the demographic that is likely to want a certain property and the condition of the property, a key factor in deciding what property to buy and where to buy it is the rental yield. In this guide we will explain more about what rental yield is, how it is calculated and what a good yield is.
What is Rental Yield?
Rental yield, at its most basic, is the amount of annual rental income as a percentage of the value of the property that is being rented.
Why is Rental Yield important?
When making an investment decision, especially when it comes to rentals, any landlord needs to know whether the investment will be financially viable. It isn’t as simple as charging rent to cover the mortgage, what about repair bills? The annual costs for inspections or covering administrative costs? Buying a property in an area with good rental yield values will help a landlord understand whether the price being paid makes sense in terms of the income coming back from the rental. A property with a large rental yield is likely to make better returns.
How to Calculate Rental Yield
There are two types of rental yield that can be calculated which are gross rental yield and nett rental yield. There are good reasons why there are two calculations and we will come on to that in a moment.
Gross Rental Yield
Gross Rental Yield does not factor in any running costs or expenses of renting the property and simply looks at the annual rent compared to the price paid of the property. Simply take the monthly rent and multiply this by 12 (or if paid weekly multiply it by 52) to get the annual rent. Divide this by the price paid for the property and multiply the answer to get a percentage value. For example, if the monthly rent is £800 the annual rent is £9,600. If the landlord paid £175,000 for the property the gross yield is (£9,600/£175,000) x 100 = 5.5%.
Nett Rental Yield
A much more accurate way to calculate the true return on the investment is to calculate the nett rental yield. This is the annual income minus annual cost such as the mortgage, insurances, maintenance and any other costs divided by the price paid and multiplied by 100. So, using the same example as above. The landlord paid £175,000 for a property and collects £800 per month in rent. With an interest only mortgage, the monthly repayments are £375. Insurance is £50 per month and typically maintenance is £75 per month. That means the total costs of the rental to the landlord are £500 per month. The nett yield is (£800-£500)x12 = £3,600/175,000 x 100 = 2.05%. This is clearly a much smaller number.
Looking at these two numbers, why would anyone use the gross value as it seems to drastically overstate the return? Quite simply, when buying a property, the exact running costs are not known and also one property’s costs will differ from another making a detailed comparison difficult. The gross rental yield is a quick and easy method to make an informed comparison between properties. The nett rental yield is, however, the true return on the investment and obviously some of the costs can be controlled by the landlord themselves to maximise the yield.
What is a good Rental Yield?
There is no clear cut answer here as a lot depends on the landlord’s business model. In general, though a gross rental yield of over 7% would be very good and should allow there to be enough cash flow to cope with the running costs of the rental.
Whilst rental yield is important, it is key to not only focus on that number. If the property has little potential to grow in value or has little to attract it to a tenant then even with a decent rental yield, it might not be a good investment. When making an investment decision, make sure to take into account all the factors and not just the potential yield.