Understanding Rental Yields
A rental yield can be calculated on either a gross or a net basis. The difference between the two is whether the yield is inclusive of exclusive of costs.
When you purchase a Buy to Let there are two ways in which you can make a return on your investment: capital growth and rental income. Usually you would look for a combination.
Capital growth refers to the change in a properties value over a period of time. Capital growth is hard to forecast and you should remember that house prices can fall as well as rise.
Rental income is the rent that you receive from your tenants. Like house prices rents can go up and down.
Calculating a rental yield of a property is a useful way to help make a decision on whether to purchase a buy to let investment. Providing you have done your calculations the rent you receive should provide you with a regular net income. This is why so many people are investing their money into properties as supplement pensions.
Gross rental yield calculation:
If you purchase a property for £200,000 and receive a rental income of £1000 per month you would work out the gross rental yield by dividing the annual rent by the investment price.
£1000 x 12months = £12,000
£12,000 / £200,000 x 100 = 6%
Net rental yield:
The net rental yield is calculated by adding in the costs.
If the property has a mortgage of £150,000 at an interest rate of 4% the monthly mortgage payment would be £500. We will allow £100 per month for agency fees and insurance.
The net rent would be £400 after the £500 mortgage payment and £100 agency fees had been deducted.
The annual net rent would be £400 x 12 months = £4800
The deposit money invested is £50,000
The net yield is £4,800 / £50,000 x 100 = 9.6%
These examples demonstrate why it is important to consider the impact of interest rates when deciding how to fund your purchase.
In this example taking out a buy to let mortgage resulted in a higher net rental yield than going down a non- mortgage route. However, if interest rates had increased to 5% the rental yield would be the same in both cases.