Buy to let investment

Investment yields

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Doing your sums accurately is an important step on the way to becoming a landlord.

Get your sums and your choice of property right and you can cover the costs of running a property for the life of a mortgage and end up with a healthy property value at the end of it all. Lots of landlords have benefited hugely from the price rises over the last few years, with some investments even doubling in value. A minor downside to this potential upside is that you have to sell the whole property in order to release any of the profit and once you do that, you lose the rental income as well.

The main risk is that if you get your sums and property selection wrong, or make a bad investment for one of the many other possible reasons that exist, you could find that your 'nice little investment' is a severe drain on your cash resources. But what level of earnings can you realistically expect?

Rental yield
The yield of a property represents the year's rental income, expressed as a percentage of how much the property's value.

For instance, say I buy a house for 100,000. I manage to rent it out for 800 per month. If I were to have no void periods in the year (which is the assumption that is usually made when calculating gross yield), I would receive 9,600. This equates to a yield of 9.6 percent.

When considering yields, remember that it is usually quoted gross. Gross rental yield can vary from as little as 4% right up to 15% or even 20% of the property value. Average rental return is around 10%, which is what your target should bes as a rule of thumb. Anything less than this is not usually going to be worth the hassle, unless your main investment objective is capital appreciation.

The net yield is calculated using the amount left after purchase fees, repairs, void periods, mortgage repayments and running costs have been taken into account. Net yields can be substantially lower than gross yields, so make sure that you are comfortable with the two types. If you are targeting a property that will rise substantially in value, a low yield is not necessarily a bad thing, as it may mean there is more scope for a rise in property value.

Some agents will quote projected net yields at around 75% of gross yields. This is very optimistic - be warned. It is more likely that your net yield will work out to be around half your gross yield. This is why ten percent is often used as a recommended minimum target for gross yield. Less than ten percent gross usually equates to little more than four or five percent net. Whilst this may be OK most years, it will not be enough in years with long void periods, lots of damage, repairs, maintenance or refurbishment requirements, not forgetting the hassle of buying the property in the first place.

Rules of thumb

  • Cheaper property will provide a better annual return. Expensive properties in prime areas provide a lower return but are likely to appreciate more in value.
  • ARLA recommends that you should look for rental income that equates to approximately 130 - 150% of the mortgage repayments. This will allow you to cover the inevitable void periods after period of occupancy, as well as maintenance, repairs, insurance, redecoration etc.
  • Finally, in the words of the CML, "potential landlords must always think about whether their investment expectations are realistic". The best way to find out whether they are or not is to speak to a letting agent.
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