December 3, 2020

Rental Yields, it’s all about the percentage!

If you are a regular reader of Elavace blogs, you will be all too aware of the significance that positive rental yields and capital gains possess in any property investment venture. The two are undoubtedly amongst the most important measures to gauge how investable a property is. For today’sblog, we are going to focus on rental yields and help any budding property investors or landlords understand how successful their current / potential investment will prove to be.

So, what is rental yield?

In a nutshell, rental yield is the likely return a property investor can expect to achieve on a property through rental income. Rental yield is always expressed as a percentage figure that’s calculated by dividing the annual rental income by the total amount that has been invested in the property. There are a selection of factors that can affect rental yield, these include property prices, rental prices, interest rates, and rental demand.

How do you work out rental yield?

-       Gross rental yield

To calculate the gross rental yield, you simply need to divide a year’s total rent by your initial investment. For example: If you purchased a buy-to-let property for £300,000 and gain £1,000 per month in rent, this forms an annual rental income of £12,000 (12 x 1,000). Therefore, the gross rental yield is:

(12,000 / 300,000) x 100 = 4%

The problem with this calculation is that it doesn’t completely answer our question. This is because the simplicity of the gross rental yield does not account for any other costs that contribute to the total amount invested, such as mortgage repayments or general upkeep of the property. These expenses always mount up which is why it is important that they are taken into consideration when proceeding along any investment path. Bringing us to our next item of agenda: net rental yield.

-       Net rental yield

Net rental yield is a much more useful measure than gross rental yield because it takes into account all other additional costs of owning a property. Amidst all the excitement of venturing into the property investment world, it is easy to neglect the consideration of outstanding mortgage repayments or interest rates into your plan.

Net rental yield is calculated by deducting all costs of owning the buy-to-let property from the total annual rental income being achieved. Then the next and most important step is to divide this figure by either the property value or initial capital outlay on the property. If you wish to compare two different investment properties based in two regions of the UK, then the former would be suited to you. This allows you to calculate which location is home to the greatest returns for your investment.

For example:

According to Zoopla, house prices in London typically average around £666,842. This means that if you purchased a property in the capital with a £550,000 buy-to-let mortgage at a fixed interest rate of 3.92%,your interest repayments will be £2,879 monthly or £34,548 annually. If you set the monthly rent at £3,500, the annual rent collected would be £42,000. Zoopla estimates that annual costs for insurance (£360), essential repairs (£900) and void periods (£3,500) total at £4760. This means that the net rental income will be:

£42,000 – (£34,548 + £4,760) = £2,692, followed by: (2,692 /666,842) x 100 = 0.40%

Then, if we were comparing investment properties in London to the Northern Powerhouse giant, Liverpool, we would follow the same suit as above.

Once again, Zoopla have calculated average house prices in Liverpool to currently stand at an affordable value of £167,223. If you were to buy a property in this region with a £140,000 buy-to-let mortgage at the same interest rate, your interest repayments will be £401.33 monthly or £4,816annually. If you set the monthly rent at £800, the annual rent collected will be £9,600. Sticking with Zoopla’s suggestion of typical annual costs for insurance (£360), essential repairs (£900) and void periods (£800) totting up to £2,060. This means that the net rental income will be:

£9,600 – (4,816 + 2,060) = £2,724, and then: (2,724 /167,223) x 100 = 1.63%

In this scenario, the clear and obvious decision to make is whether to buy just one property or an entire portfolio of properties in Liverpool!

On the other hand, if you are an investor on the market for a different investment path altogether, the division of the initial capital outlay on the property is the best method for you to calculate the net rental yield. This will all sound a lot more complex than it really is, but the only difference this time is that the amount borrowed in the mortgage will be subtracted from the property value.

For example:

Purchasing a property in London valued at £666,842 with a £550,000buy-to-let mortgage with annual repayments mounting up to £34,548. You will still collect £42,000 in annual rent, as well as all other additional costs coming to £4760. The net rental income will be £2,692, however, on this occasion we will be dividing this figure by the capital outlay (£116,842) instead of the property value (£666,842).  

(2,692 / 116,842) x 100 = 2.3%

Jetting back up to the North-west, where we purchased a property for £167,223 using a £140,000 buy-to-let mortgage with annual repayments of £4,816. Not forgetting to collect the annual rent (£9,600) and factor in all other annual costs (£2,060). The net rental income remains £2,692 but the capital outlay is £27,223. Therefore:

(2,692 / 27,223) x 100 = 9.8%

But what do these two figures mean in relation to the property investment world? The short answer is an awful lot!

What is a good rental yield?

Now for the long answer. A good rental yield for a buy-to-let property can be anywhere in the region of 7% or above. As we have already touched upon, albeit briefly, you mustn’t forget to factor in all other costs like mortgage repayments, general upkeep, and even insurance into your investment plan. This is why Elavace use 7% as a general rule of thumb to ensure we achieve our mission to provide all our trusted partners with strong enough cashflow to withstand any potential hurdles. This is why selecting the best area to invest in is of the essence when it comes to property investment!

So, where are the best buy-to-let yields?

For a number of years, the property market in the North was largely overshadowed by that of the South which made the decision of where to invest very easy for property investors. However, properties in and around London rose in price so aggressively that they eventually priced out many investors and homeowners. Thus a large portion of these buyers decided to follow the money and move their investments further afield to the North of the country for lucrative rental yields and stronger capital gains.

Elavace recognised this movement in market activity and after conducting a vast analysis on the northern regions went on to specialise their portfolio specifically to the North-west which was highlighted as the number 1 region for their investors and partners to maximise their investments.

Just take a look at the top 15 buy-to-let postcodes for 2019/2020:

Source: https://www.totallymoney.com/buy-to-let-yield-map/

What about the worst buy-to-let postcodes?

 Source: https://www.totallymoney.com/buy-to-let-yield-map/

The numbers say it all!

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