A Landlord’s Guide to Rental Yield
Published on August 14, 2019 by Sarah Mac
For any landlord, rental yield will be a top consideration. It’s the key indicator of whether an investment is going to be a sound one. It’s also a crucial factor for lenders when making a decision on whether a buy-to-let mortgage is affordable.
Being aware of how to calculate rental yield is essential to you as a landlord. In this post we will explore how to work out gross and net yield, and look at the vital things to consider when making those calculations.
Rental yield explained
Rental yield is the return achieved on a rental property. To work it out, you divide your annual rental income by the total value of the property. The value includes the initial purchase price plus any improvement costs already incurred or expected in the future.
Yield can be calculated as net or gross. This depends on whether the running costs are included. Mortgage lenders will usually focus on gross yield.
Rental yield and capital appreciation
It is vital to remember that rental yield is not the only factor to consider when thinking about property investment. Capital appreciation is also very important. This covers how much the property has risen in value and may increase in the future.
If you are considering selling in the future, capital appreciation is something to bear in mind. However, if your long term plan is to pull in a rental income, then you will usually look to rental yield as more of an indicator of a worthwhile investment.
How to calculate gross rental yield
The rental yield calculation is a fairly simple one. Gross yield is calculated as follows:
- Firstly, take your annual rental income. For example, £300 per week = £15,600.
- Now take the price you paid for the property and any improvement costs. For example, £180,000 purchase price + £20,000 improvement costs = £200,000.
- Divide the annual rental income by the property price. For example, £15,600 divided by £200,000 = 0.078.
- Now multiply the figure by 100 to get the gross yield percentage. In this case it’s 7.8 per cent.
How to calculate net rental yield
To calculate net yield, you’ll need to factor in running costs and additional expenses. This will give you a more accurate picture of how much your investment will be pulling in for you. Let’s take a look at some of the additional costs that you should factor in when calculating net yield.
Wear and tear
There will more often than not be costs incurred at the end of a tenancy to deal with wear and tear. A professionally compiled, unbiased inventory report will protect you against malicious damage and negligence and provide the evidence you need to recoup the costs from the tenant’s deposit. There will however be natural wear and tear costs that you will have to absorb yourself, and you’ll need to redecorate periodically so that the property stays appealing to new tenants and worth its rental costs. Mid-term inspections will help you keep an eye on deterioration of fixtures and fittings so you can plan ahead for the costs of replacing items.
The older the property, the greater the maintenance costs you can expect. You are looking at things like roof and guttering repairs; door and window maintenance; damp management and dealing with issues such as leaks and blockages. Boiler servicing and repairs will also fall under the maintenance related outlay.
Leasehold properties will command ground rent and service charges, so these will need to be factored in when calculating net yield. These charges will all be set out in the lease agreement.
Most rental properties won’t be let 100 per cent of the time. Vacant periods where there is no rental income need to be considered for net yield calculations. Usually accounting for one month’s missing rent should be sufficient; things don’t usually go further than that.
Many landlords employ the services of a managing or letting agent to take care of their property and deal directly with tenants. These services will incur a fee which is usually based on a percentage of the rental income. This percentage will vary depending on location.
Any loans or mortgages connected with the property will incur fees, and these will form part of the costs for net yield purposes. If you’ve put a deposit down on a mortgage, then this will be included in the finance costs.
Landlord insurance varies in price according to the property type, size and location. As a general rule, you can expect to pay in the region of two to three per cent of the rental income. If the property is furnished however, the premium will usually be higher. If you opt for rent guarantee insurance, you’ll also pay more, although it can be a worthwhile investment.
As soon as you have summed up all the costs involved in running your rental property, these should then be deducted from your rental income. You can now recalculate your gross rental yield so that it gives you a net or true yield.
Also bear in mind that you may be able to claim certain costs back against your tax, although it is good practice to account for them when calculating your yield, so that anything you do claim back will act as a bonus.
What can be considered a healthy rental yield?
Rental yields will vary depending on property type and location. Whilst there is no hard and fast rule, it is wise to allow at least enough to cover running costs and mortgage and / or loan repayments. It is also good practice to have a contingency fund in place so that you are well placed to cover any unexpected expenses that tend to crop up, such as boiler breakdowns or leaks.
Researching rental yield, whilst bearing in mind the typical factors of the particular area, is vital before making your buy to let investment.