The most important thing to learn if you are hoping to achieve big things in buy to let investment is how to calculate net rental yield. After all, you are in it for the money and if the financial side doesn’t stack up, then you could be wasting your time and money.
To help us understand how to calculate net rental yield, let’s use the example of Richard:
Richard is looking for property that will earn him a good return on his investment over time. He looks at all the available options and settles on two for comparison.
The first property is valued at £130,000 with a potential rental return of £600 a month
The second property is valued at £200,000 with a rental return of £850 a month
Which property should he invest in? Should he invest in the first property which will have lower upfront costs and mortgage payments or should he go for option two, which offers £250 a month extra income?
This is where calculating the yield from these buy to let properties will help Richard to decide which offers the best investment.
The basic formula used for calculating the gross rental yield (this is an important distinction we will return to later) is as follows:
MRR = monthly rental return
I = investment
Yield = MRR x12/I x100
Richard's rental yield for the first property would be:
Monthly rental return = £600
Investment = £130,000
£600 x 12 = £7,200
£7,200 / £130,000 = 0.0553
0.0553 x 100 = 5.54 % yield
His rental yield for the second property would be:
Monthly rental return = £850
Investment = £200,000
£600 * 12 = £10,200
£10,200 / £200,000 = 0.051
0.051 x 100 = 5.1 % yield
So in this example and looking purely at a simple calculation of the yields on both properties, Richard would be better off investing in the cheaper property because the yield on that property is higher. Now this kind of yield is not far off the average in many UK cities, however this basic calculation still won’t give Richard enough information to make a final investment decision.
To make that decision he will need to look at several variables and factor in costs such as:
Advertising for Tenants
Cost of redecorating/maintenance
Running costs during void periods
Costs of furniture and white goods
Deducting these costs will give a truer picture of the actual return on investment from the property referred to as the ‘Net’ yield. If you can deduct these costs from your gross yield and still achieve a yield of more than 5%, this will be a good return on investment.
Another point to consider is that rents will inevitably rise over time. This will only increase your likely yield and there is also capital growth to consider. The value of the property itself should also rise over time, assuming you invest well.