When you invest in property, you should always be focused on your rental yield. Whether you are a newcomer to property investment or an experienced landlord with a portfolio of properties, you cannot afford to overlook the process of calculating the rental return your properties will generate.
What is rental yield?
Rental yield is the return on investment you are likely to achieve through rental income. It is presented as a percentage, calculated by dividing the annual rental income of the property by the total amount you invested in it.
Why is rental yield important?
In the world of property investment, maximising cash flow through a good rental yield is the most important objective, followed by capital growth.
- If your income falls below your expenditure, you are losing money.
- If you are breaking even then you are not making any profit from your investment.
- And if your income leaves no room for contingencies then a problem with the roof or a broken boiler can leave you seriously out of pocket.
When you are aiming to succeed in the buy-to-let market, you should always be focused on ‘long-term sustainability’.
How to Calculate rental yield?
To determine the rental yield of a property, you must take the annual rental income and divide it by the property’s price. Then you multiply this figure by 100 to obtain a percentage.
So, if your property was purchased for £250,000 and your annual rental income is £15,000 the calculations look like this:
- 15,000 ÷ 250,000 = 0.06 x 100 = 6
So the rental yield is 6%.
This is a pretty good measure of a property’s rental return, but there are other things that need to be considered. For example, if you take out a mortgage for your buy-to-let property, you must factor in the repayments when calculating your return on investment. You need your rental income to cover all the running costs of the property so that you don’t need to dip into your contingency fund frequently.
BMV deals and Capital growth
Capital growth is an important element of planning your property portfolio. It involves choosing an area to invest where house prices are on the rise in order to make a profit in the long term. Similarly, it is wise to look for below-market-value (BMV) deals to grab a bargain on a property with good profit potential.
While these are important components, focusing solely on capital growth and BMV deals can mean you ignore the rental yield and miss out on some significant gains that could have been made. Making sure the property pays for itself from one month to the next is much more important than grabbing a discount at purchase or a hypothetical profit at the point of selling.
What is a good rental yield?
Based on our experience, we would suggest a rental yield of 6% or higher is good for buy to let properties. Some would recommend targeting something in the region of 5-8% as a good target range. Anything below that could risk not having enough cash flow to cover the property’s running costs plus mortgage repayments and unforeseen problems. Of course, if your mortgage loan to value (LTV) is lower than average then you may have more cash flow in the property.
When you are searching for an area to invest in property, you need to check that the rental returns there make financial sense. Areas that offer an excellent rental demand or capital growth potential can be extremely tempting. Add in a BMV deal and it could look like a no-brainer. But if the rental yield is only around 4%, it is unlikely that your monthly income will be enough to cover baseline costs and mortgage repayments.
Investors who focus more on capital growth, with low gearing and the ability to purchase in city-centre locations, may be an exception to this general rule of thumb. These people often place potential growth at the forefront, so rental yield is a secondary consideration.
What costs need to be covered by the rental income?
Many property investors often overlook the importance of a healthy rental yield, and monthly cashflow. This can lead to problems down the line.
To ensure your investment is sustainable in the long-term, the rental income must cover the property’s running costs. It is also extremely important to factor in a contingency budget. It is wise to expect the unexpected – your costs may suddenly increase without warning and you can’t afford to be caught unprepared.
One example to consider is that mortgage interest rates are very low at the moment – part of an incentive to encourage buyers in the midst of a global crisis. When those rates return to normal levels, landlords whose property has a low rental yield could find their investment suddenly loses its viability.
Mortgage repayments are but one of many expenses. Your rental return also needs to cover:
These are all expenses that can fluctuate, so you need to be prepared. Of course, costs can sometimes go down as well, but you need to be prepared for when they go up. Things like boilers and roofing can develop significant problems with no warning, and the associated expense can be huge.
What makes a good buy-to-let investment?
A good rental return is one of the most important considerations when choosing a buy-to-let investment property as it generates cash flow. But a wise investor considers everything, and there are other elements you need to balance out. Simply put, while it is extremely important to get a rental yield that covers all the costs, that doesn’t necessarily mean you should only be targeting the highest possible return.
For example, some parts of the North West and North East achieve rental yields as high as 10% for single let properties. Does that mean they are excellent investment opportunities?
These types of houses have little prospect of gaining in value. They also tend to attract tenants who are difficult to deal with and notoriously unreliable. Furthermore, these properties are not easy to sell, could be non-standard construction and even unmortgageable. Golden rule, a sound investment should always include a strong exit strategy.
Property value, yield and growth
The best property investments manage a fine balance between a number of factors. Finding the happy medium is the key to success.
Many investors will indeed aim to secure a rental yield above 7%. But they will also consider factors like:
- Capital growth potential
- High tenant demand
- Tenant profile
You need to gain a strong understanding of the elements of property investment before you begin looking for a buy-to-let property. This will put you in a strong position to make the most suitable choices and maximise your chances of success.
Think Plutus can help
With a wealth of experience and qualifications in the mortgage market, the team at Think Plutus has seen it all. We have a robust knowledge of the buy-to-let market and can advise on what to consider, whether you are just entering the market or you are an experienced landlord.
As a whole-of-market mortgage broker, we can assist with one of the most fundamental elements of success: finding the right mortgage. We can compare thousands of deals from over 100 lenders to find the most suitable buy-to-let mortgage for your needs.
Contact Think Plutus today and take the first step towards success as a property investor.