Stacking up a deal to figure out whether a letting property is worth the time and bother of buying and doing up is a regular exercise for landlords.
Property professionals generally have a checklist to tick off the pros and cons of buying a home – and one of the important factors is yield.
Yield is the return a landlord can expect to see on their investment.
Sometimes called ‘return on investment’ or ROI by accountants, the calculation returns a percentage based on the cost of the property and the income generated during the year.
The rule of thumb is the higher the percentage, the greater the yield, so the better the return on investment.
Yield is generally worked out as a gross figure.
- Gross yield is total annual income divided by the property value times 100.
- For example, a buy to let that is worth £100,000 and generates £6,500 rent a year.
The yield is (6,500/100,000) x 100, which is 6.5%.
The figure is gross because the calculation does not include any property business expenses.
Working out the net rental yield is a similar calculation, but the running costs of the property are subtracted from the annual rent. These costs cover expenses such as mortgage interest, insurance, letting costs, repairs and maintenance.
If the annual running costs of our buy to let property are £2,500, the net yield calculation becomes ((6,500 – 2,500)/100,000) x 100, which is 4%.
The problem with the yield calculation is that to make sense of the figures, a benchmark is needed.
Find this by grabbing the rents and values from web sites of similar letting properties within half a mile or so and calculating their gross yields.
- From these calculations, take an average by adding up the gross yields and dividing by the number of properties.
- If the gross yield for the property you are viewing is at the same level or higher than the benchmark yield, then the calculation is telling you the investment stacks up.
- If the gross yield is lower than the benchmark, either the rent is too low or the price is too high or a mix of both.
Don’t forget the yield figure in isolation is no good without a benchmark figure to put the result in context.
When considering a purchase, you should also factor in the following:
- You will likely have expense at the beginning to bring the property up to rental standard. This can often be considerable and should be included in the initial purchase cost when considering any yield.
- Always assume there will be 2 months void / rent arrears each year.
- Could you afford the mortgage if you had to seek possession against a tenant who wasn’t paying? This can easily take 6 months, sometimes more.
- Almost every change of tenant (on average every 18 months) you will need to carry out some works, repairs and decorating.
- Around every 10 years or so you will commonly need new kitchen, bathroom and flooring. Renters do not look after property like they would their own.
- Boilers generally only last between 5 and 10 years after which expensive repairs or a new one is required.
- If you supply white goods, these will require repair and are prone to regularly breaking down.
- A simple leak in a roof can turn out very expensive after bad weather especially if scaffolding is required.
The simple reality is that to make even a small amount of profit after the mortgage has been paid you really need a yield of 10 – 12%. Anything less will result in it being very difficult to make a profit until the property has been paid for.
You may think these yields are simply not possible to find but that is not true. You just have to be patient. That being said, we do understand that it is very difficult to find such returns.
Best investment advice for a buy to let that I have read for a long time. Meeting the mortgagors interest cover requirements has seldom been sufficient to stay in the game for the long run.