It is always important when considering whether you wish to become a buy to let landlord that you understand what rental yields mean.
We explain below what a rental yield, how to calculate it and what can affect it.
You need to understand when dealing with Buy to let properties that you are either investing on a medium or long term basis. A buy to let property unless you are purchasing in cash may not give you the return that you are looking for. There are many factors that can affect the yield including property prices, interest rates, rent and tenant demand. So you need to decide on whether you are a long term of short term investor and it may not be for you.
How to calculate a rental yield?
There are two different types of rental yield one is gross and one is net.
You can calculate gross rental yield by dividing a year’s total rent by the purchase price of the property and multiplying it by 100.
For example if you bought a buy to let property for £400,000.00 and received rent of £1500.00 per month it would give you an annual rent of £18,000.00 i.e. 12 x £1500.00 and the gross yield is worked out as follows (£18,000.00 divided by £400,000.00 x 100 = 4.5%)
But, the above doesn’t give you a reflection of the gross yield as it is only a simple calculation. It doesn’t take into account for instance the purchase costs i.e. stamp duty, solicitor’s costs etc. and any renovations you may wish to make. You should always add these into the price and that would give you a much better idea of what the return is.
It doesn’t end there unfortunately. You then need to look at any day to day costs such as letting agent’s fees, mortgage repayments, insurance and upkeep of the property. These need to be considered when you are looking to provide yourself with a good return on the property.
What is the net rental yield and how is this calculated?
Net rental yield is often a better measure to use than gross because it takes into account the cost of owning a property including any outstanding mortgage repayments and various costs.
It is calculated by taking the annual income minus any costs associated with owning the buy to let property. Then depending on the definition of the net rental yield you wish to use it can be either divided by
- The property value or
- The initial capital outlay of the property i.e. the full amount that it cost you to purchase it.
If for instance you bought the property for £190,000.00 with a buy to let mortgage of £140,000.00 fixed interest rate of 3.4% your interest rate payments would be £401.33 monthly or £4,816.00 annually. However, if you set the monthly rent at £800.00, the annual rent would be £9,600.00.
You may have other typical costs such as insurance (don’t hesitate for us to give you a quote) general repairs, letting agent fees, and potentially void periods. Void periods are when the property is empty and you are not receiving any rent. If for instance you took these costs overall at say £2,060.00 per annum this would then mean that the net rental income would be £9,600.00 minus the mortgage of £4,816.00 minus £2,060.00. This would leave the overall income of £2,724.00 you then divide by the £190,000.00 it cost you x by 100 equals the percentage of 1.43%. You can see therefore being a net calculation can make a huge difference.
Now let’s look at another example.
The first part is the same you are buying it for £190,000.00 on a buy to let mortgage and other costs. The net rental income is £2724.00 but instead of dividing it by this figure you divide it by the capital outlay i.e. what it actually cost you. This is the deposit that you put down. This would then be a return of £2,724.00 divided by £50,000.00 x 100 equals 5.45%.
You can see that both of these show the true terms of a buy to let can be reduced by the overall costs.
But, this isn’t the end of the calculation. You then need to take into account your own tax position. Say for instance you earnt £3,000.00 per annum on the property but you were a 40% tax payer the least you would be paying in tax would be £1200.00 and you could see it is quite a large deduction. This is why buy to let properties are very much long term projects. Unless you are purchasing in cash and it is your only income then you are eventually just using the money to pay the mortgage off as quickly as possible. Once you have paid the mortgage off then the investment comes to fruition and you are able to use the income.
Which net rental yield should I use?
It depends on what you decide. If you are trying to decide which City to purchase a buy to let in, then the rental yield that looks at the property value allows you to compare like for like. For example how much profit you will make from a £200,000.00 home in each location given the likely rental and costs. Obviously you need to take into account the tax position.
If you are an investor looking to compare whether the buy to let would be a better option than say stocks and shares then it is your capital outlay that you want to use.
It is often the case when buying property where you have got a mortgage that you are really looking to gain the yield when and as you have paid off the mortgage. You also have to take into account your tax position as well. What do you want the income for, is it something that you need now or at a later date.
You also need to understand am I buying a property for income at a later date or alternatively growth in the value of it. It is very misconceived by many buy to let investors that properties will always go up. This is not the case. You must take into account that prices go down as well as up which is why property is often a long term rather than a short term investment prospect. Consider whether you need the money or now or at a later date. Don’t rely on the property being worth money in the future it is not always the case.
Can I maximise the rental yield? You can, rental yields vary depending on factors such as current mortgage rates, taxes, release available and the fluctuation in the rental property market. Always take all of these into account.
You could increase the rent.
You might find that the rent is lower than the open market value and you may be able to increase it. Yet you need to understand that Assured Shorthold Tenancies are for a fixed period i.e. six or twelve months and you cannot increase the rent within that time period. It can only either be done by renewal or at the end of the tenancy with a notice. You should speak to your legal advisor in this regard.
Don’t under estimate the worth of reliable long term tenants who will take care of your buy to let property. The loss of income incurred by one vacant month when you have a change of tenant could take anywhere up to two years to recoup through a rent rise.
Look to supply a lower rent.
It sounds like a contradiction but in real terms if the rent is too high against the property for the area then lowering the rent can ensure that you don’t get any void periods. These are periods whereby you get no income at all because the property is empty.
- Utilise your tax credits.
There are new buy to lets tax systems that have been gradually phased in and it is important therefore that you speak to your accountant. You can no longer deduct mortgage interest from your rental income when calculating the tax you owe. Instead all of your income will be taxed and you will qualify for a 20% tax credit for your mortgage interest rate.
Update the property.
Expectations amongst tenants are higher than ever so follow suit by putting in a decent kitchen and bathroom as well as speaking to a local agent who will know the market.
Be pet friendly.
There are millions of pet owners in Britain and there is a huge market for allowing pets. You may find that you would be able to even increase the rent.
Lower your overheads.
This can mean anything from re-mortgaging to a better deal or sourcing out cheaper contractors.
Where in the UK should I look to purchase?
Zoopla revealed in September 2020 that the highest areas were Middlesbrough in North Yorkshire and East Ayrshire, North Ayrshire, Inverclyde, all in Scotland offering the highest rental yields in the UK.
These regions rank in the top 10 hotspots for investors looking for UK rental yields. They all provide in excess of 7% gross yield thanks to a combination of low property prices and a steady monthly rental.
What other high yielding places are there?
According to Zoopla the North East of England is the most dominant area and always in the top 10 thanks to an investor triangle of Sunderland, County Durham and Hartlepool.
Sunderland and County Durham both generate a 7.4 gross average yield whilst Hartlepool has now reached 7.3.
What about the London area?
Prices in London have a massive knock on effect on rental yield. London is no exception. However there are still areas within the capital that can provide yields where compared with the average in the UK of 5.2.
Barking and Dagenham have had the highest yield of 5.3 and the Boroughs of Newham and Havering have an average of 4.9.
Why not look at the Zoopla house price index for July 2020 and the link below gives you the up to date information
Choosing the right location with Buy to let investment relies on a multiple of factors. Landlords need to weigh up the convenience as well as the profitability to pinpoint the best place for them.
If you are an experienced property investor or one about to start with your step on to the housing ladder then where you invest is hugely important. The housing market is forever changing and buy to let opportunities vary across the country. Even experienced landlords have a tendency to try and stick to tried and tested locations as staying ahead of the market is an important aspect.
There is often a north/south divide that comes into play when choosing to invest. It is important that you do your research on the property market and where you may wish to purchase your buy to let. Don’t hesitate to contact us if you want an insurance quote on any property you may have.