The Property Owner’s Guide To Calculating Rental Yield
Landlords that invest their money into buy-to-let property do this to generate a profit and treat their property assets as part of their business. For these landlords, it is more critical to understand rental yields than it would be for an accidental landlord that has inherited a property and lets it out to provide them with a bit of income and security for their future.
It makes sense for a landlord to protect their assets with comprehensive landlord insurance to cover the expense of any unexpected events that happen to their property, such as a devastating fire, flood or storm damage. However, ensuring that the rental yield of the buy-to-let property will more than cover all of your associated expenses is the only way to guarantee a profit from your property.
But what exactly is rental yield, and why is it a term bandied around so much in landlord circles? In this guide, we look at rental yield and how it can help you as a landlord to make a decent profit from your buy-to-let property.
What is rental yield?
Rental yield is the annual rental income expressed as a percentage of the rental property’s total value. Rental yield is also known as property yield and is used as a benchmark figure when comparing buy-to-let properties.
For a landlord looking for new buy-to-let property investments, calculating the rental yield will be a good indicator of whether or not an individual property will be worth your investment. The amount of return depends on many factors, including:
• Capital appreciation
• Demand growth
• Fluctuations in the housing market
• Interest rates
• Property prices
• Regional disparities
Assessing all these points will help you decide whether you add a particular property to your portfolio or if the property doesn’t promise a good yield and better options are available.
Rental yield can also fluctuate once you have purchased a property, so buy-to-let landlords will keep an eye on these figures and decide whether to keep a property or sell it and find another to invest in with more promise of a higher rental yield.
What’s a good rental yield?
Generally, a good rental yield in the UK is considered good when it is above 8 per cent for a buy-to-let property. Rental yields of this level or above should be more than enough to cover your buy-to-let mortgage costs, property maintenance costs and any unforeseen expenses such as emergency repairs.
However, while a good rental yield over 8 per cent or above will usually give landlords enough return to cover costs and provide them with some take-home money, which is the overall goal for buy-to-let investors, it may not cover the costs of any extended periods where the property stands empty, and you won’t be receiving any rental income.
For example, should a fire on the property renders the premises unsafe for your tenants, you will need to move them out and won’t be charging them rent. This is why landlords should protect themselves with landlord insurance that includes covering loss of rent while repairing and refurbishing the property following a fire to make it safe for tenants to move back in again.
How do you calculate rental yield?
Working out your rental yield isn’t entirely straightforward. There are different ways to calculate the rental yield of a property, and which way you choose to work this out can give you a general idea or a more precise figure if you need to be sure of your calculations.
One of the easiest and most popular ways to calculate the rental yield of a potential new buy-to-let property is to take the yearly rental income and divide it by the property’s value (the purchase price). This figure is then multiplied by 100 to get the rental yield percentage.
Calculating the gross rental yield of a property:
For example, this is a simple calculation using this formula: Annual rent income (weekly rent amount multiplied by the number of weeks in a year, 52) ÷ property value x 100.
• Property annual rental income = £12,000
• Property value (purchase price) = £200,000
• Calculation = 12,000 ÷ 200,000 = 0.06 x 100 = 6
This means that the rental yield for this property is 6 per cent. This is just under the target 8 per cent figure that would provide a more desirable rental yield for a buy-to-let property, so a potential buyer may be cautious about taking on this property. Landlords need to remember that fluctuations can happen, so even though this property isn’t hitting an 8 per cent rental yield, it may do in the future.
Another example of working out the gross rental yield is if your property is worth £150,000 and your tenant pays £450 per month:
• Property annual rental income = £6,600
• Property value (purchase price) = £150,000
• Calculation = 6600 ÷ 150,000 = 0.044 x 100 = 4.4
This gives you a 4.4 per cent gross rental yield for the property. While this may look OK, don’t forget that you need to factor in your landlord expenses, so working out the rental yield of a property and if it will be profitable or not goes further than just the rental yield number.
Calculating the net rental yield
The net rental yield of a buy-to-let property may be a better way to work out your profit margins. This is the figure you arrive at after deducting all your landlord expenses, such as letting agent fees, property maintenance costs, accounting fees, landlord insurance, etc. If applicable, you should also include other costs such as Stamp Duty Land Tax.
Let’s say you have an annual cost of £3,000 to cover your landlord expenses. Using the same property figures as above:
• Annual rental income: 6,600 – Landlord costs: 3,000 = 3,600
• 3,600 ÷ 150,000 x 100 = 2.4
This reduces the rental yield to 2.4 per cent. Not such an appealing prospect for a landlord, especially if something serious happens, such as a tree falling on the property during a storm that costs £5,000 in property repairs.
This is why landlord insurance adds an extra layer of security for buy-to-let landlords, especially if they have properties with low rental yields.
Fluctuations in rental yield
When considering a new buy-to-let property calculating the rental yield is a handy way for investors to determine if the property is worth buying. However, it helps to look at the local property market and whether it is in an up-and-coming neighbourhood.
While a property may not initially generate a positive cash flow once bought, if the local area is about to undergo a significant regeneration with investment from the government and local authority, it may prove to be a wise investment shortly.
Keeping a finger on the pulse of housing market fluctuations is essential if you only intend to own a property for a few short years before selling. Many property investors buy properties to improve and flip for a profit, but if the property has a low rental yield when it comes time to sell, you may find it difficult to sell and make a profit from your investment.
Using a rental yield calculator is a handy way to quickly and easily determine whether a buy-to-let property’s potential rental yield is worth your investment. It will allow you to avoid properties with low rental yields, which are an unattractive prospect for buy-to-let property investors.
Landlords must ensure that the rental income will cover the costs of maintaining and running the property. Without a good rental yield, you will be susceptible to significant financial losses, mainly when covering common rental property issues such as boiler replacements, frozen pipe repairs and storm damage to roofs and garden fences. Running a small business? Discover affordable and comprehensive business insurance solutions at Brisco Business.
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