How can I work out the gross and net rental yield on a potential property investment?

• Posted by Ben James
• Date 14th June 2016
• Leave a comment

The key to successful buy-to-let investing is generating income. The simplest way to calculate how much income a property generates is the rental yield. This is the rental return as a percentage figure of the property purchase price. 

The gross rental yield percentage calculation is worked out by dividing the gross annual rent by the purchase price wheres the net rental yield is calculated by dividing the net annual income by the purchase price.

If you were charging £750 monthly rent, or £9,000 a year, on a £150,000 property your gross yield would be 6 per cent. But in reality, this is only the yield you will get if you are buying the property outright in cash. The actual return will be different if you are using a mortgage.

To work out your annual return or yield you first need to minus the mortgage costs from the amount you are getting from rent. After all, any rent you get needs to cover the mortgage payments before you can take any profits. You want to borrow £110,000 for a £150,000, giving you a loan-to-value of 73 per cent. You can get a competitive fee-free two-year fixed rate mortgage at this level at 3.64 per cent from Santander. For a £110,000 interest-only buy-to-let mortgage, payments would be £334 a month, or £4,008 over a year. If you are charging £750 rent a month you will get £9,000 over a year. Take off the mortgage payments and that leaves £4,992 from the rental income.

To calculate the return on your investment you need to calculate this sum as a percentage of how much you have put down to buy the property. You will be paying a £40,000 deposit, but there are other buying costs such as stamp duty, legal and survey fees. In this scenario you would pay £500 stamp duty, and other buying costs could amount to around £1,500 giving you a total of £42,000. With rent after mortgage of £4,992, this gives you an annual return of 11.9 per cent on your £42,000 investment. 

That sounds very tempting indeed, but this still won't be your actual return. You need to think about your other costs as well. It's useful to think of your income as the amount of rent you have left over after all the other expenses associated with being a buy-to-let landlord have been paid. Before you start spending that profit, remember there are other costs that will push down your returns such as maintenance, insurance, lettings & property management fees amongst other landlord expenses (circa 15% of the monthly rent).

The biggest hit to annual returns can come from rental voids - months when your property sits empty between tenants, so it's important that you a) target the correct demographic of tenant and b) furnish the property to such a standard that the tenants don't want to leave. In terms of tax offsets, in light of the recent budget changes, a lot of landlords are purchasing rental property in limited company names to continue taking advantage of offsetting mortgage interest against tax on rental income. And those with existing portfolios in their personal names are either looking to transfer their portfolio to a company set up and take advantage of incorporation relief or simply sit it out and do nothing as the changes are structured to take place over a four year period. 

It is also important to consider that the reason why your annual rental return has been magnified is that you are buying with borrowed money and if invested wisely, we consider that to be leveraging good debt. That also has the power to boost your return on investment if house prices rise but will also increase your losses if they fall. Your deposit will take the hit from any fall in the property's value, while the mortgage you owe will stay the same.

Investing in property can be a tricky game and requires a lot of knowledge, skill and research. If you'd like any advice please get in touch or simply add a comment below, we'd love to help.

Thanks for reading,

The Estateducation Team.