Rental Yield – estate agent slang, meaningless numbers or a helpful tool for LandLords?
Yields are typically used to describe the interest that an investor will receive on an investment, be that bonds or equities, over a period of time. Rental yields work on a similar principle, the rental yield of a property is the annual rent received by the LandLord as a fraction of the initial amount invested.
Example 1) In simple terms this means that a property purchased for £100,000 with annual rent of £5,000 has a 5% rental yield.
This simple equation is not particularly helpful in reality, because there are a lot of outgoings that will reduce the net income of a buy-to-let property. These costs are frequently overlooked when the rental yield is too heavily focussed on and with an increasing number of people wanting to become buy-to-let investors this needs to be considered using a birds-eye view.
Mortgage costs – buy to let mortgages are frequently offered by banks on an interest only basis, with a minimum 25% deposit, and required monthly rental 125% of mortgage repayments. It is well known, that with property prices increasing, a 25% minimum deposit is increasingly difficult to find; particularly when a LandLord has a portfolio of properties.
A 125% gross rental yield would require a property of £400,000 with a £300,000 mortgage to achieve rent between £1400 and £1590 pcm (approximately).
Why do banks require such a high return before lending money (other than FCA guidelines and caution after the sub-prime mortgage scandal)?
As a LandLord, you will find yourself dealing with additional costs, such as tax, insurance, maintenance, voids (when the property is untenanted) and marketing costs if you do not have a ready stream of tenants. All of these outgoings eat into your income as a LandLord and need to be considered when entering the world of Buy-to-let to ensure that you can make these mortgage repayments. This may be a frustration to LandLords in areas where rental yields are comparatively low and the rental market is something like 28 Weeks Later, with renters out-bidding one another and clambering for the next property, particularly when other areas do not experience such high demand. Banks, however, are not interested in the rental demand in a specified area, they are only interested in the numbers, as markets can always change.
What a lot of LandLords look for, which mortgage lenders are less interested by, is capital growth. This gives the LandLord a better idea of his/her true return on investment. This is the equivalent to the net cash flow of an equity investment, where the investor anticipates an annual dividend, as well as considering the market value of the share. It is the marriage of the rental income and the projected capital growth the LandLord should really be looking at when considering an investment property and its potential.
The overall yield of a buy-to-let property is a combination of the net rental yield, and the net capital growth of the property. This means that should the property fall in value, when the LandLord comes to sell, he may still have a sufficiently strong rental yield to warrant a loss from initial investment. Alternatively, the LandLord may decide to hold on to his investment until an upturn in the property market, delaying the sale of the property for a couple of years.
Ultimately, rental yields and yield on investment, when used correctly are a valuable tool; so if you're considering entering the buy-to-let property market, look at the bigger picture. No buyer purchases a property without a Chartered Surveyor investigating the property, because everyone wants more than the estate agent's patter, so make sure that you become the surveyor of the financial elements of the property when entering Buy-to-Let.
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