Guide to Rental Yield
When buying a property as an investment, you will need to know what the annual return (or rental income) is in order to work out if a property is worth buying. This is known as the rental yield. It is expressed as the amount of rent you receive as a percentage of the property’s value. It applies whether you’re buying a property outright or with a buy-to-let mortgage. Bear in mind that a number of factors can affect rental yield such as regional disparities, property prices, capital appreciation, interest rates and the fluctuating housing market.
There are 2 types of yield that you will hear about:
Gross rental yield is the simplest to calculate by dividing a year’s rent by the purchase price (and multiplying by 100 to give you a percentage return). However, this doesn’t take into account a number of costs that you will need to budget for. In this respect it is not a true reflection of rental yield.
Net rental yield is a more accurate figure to use as this takes into account costs which you will have to pay whether the property is occupied or not. These costs include the following:
- Your mortgage costs (if you have one) as well as your initial investment i.e. your deposit, stamp duty and any additional costs
- Insurance premiums
- Service charges and ground rent (if applicable)
- Empty (or void) periods
- Letting agency fee (if applicable)
Once you have deducted these costs from the rent, you end up with a ‘true’ net rental yield.
The example below is based on a buy-to-let mortgage with a 25% deposit and an assumed interest rate of 3.4%.
- Property value = £400,000
- Initial investment (deposit plus stamp duty)= £110,000 (£100,000 + £10,000)
- Mortgage repayments (3.4%) = £10,200pa
- Rent = £16,800pa
- Gross rental income per year (rent – mortgage repayments) = £6,600 (£16,800 – £10,200)
- Additional costs below = £4180
Service charge and ground rent: £800pa
Buildings insurance: £300pa
Agent fees: £1680pa
Void periods £600pa
- Net rental income (gross rent – costs) = £2420 (£6600-£4180)
- Net rental yield: (Net rental income/initial investment x 100) =2.2% (2420/£110,000 x 100)
In the above example the gross rental yield would work out at 4.2% (£16,800/£400,000)
Generally speaking, in the first few years of letting a property, the mortgage payments may be higher than the rental yield. Overtime, if the investment was well-made, there should be capital growth and a fairly good rental yield.