Buy to let rental yield…what is it and how is it calculated?!

Landlord Expert
By Landlord Expert November 18, 2014 14:39

The simplest calculation of rental yield involves dividing a property’s price by the yearly rent. Take the real example of a flat priced at £500,000 commanding a rent of £850 per week. The yield is 8.8pc, arrived at by dividing £500,000 by £44,200 (£850 multiplied by 52 weeks).

When mortgage lenders talk about rental yield this is almost always what they mean. And research that refers to buy-to-let yields in various cities or on various property types is usually calculated in this way too.

But this is a “gross yield”, in that it takes into account none of the costs associated with owning the property.

It is less helpful to a landlord hoping to achieve an income after costs from their investment. They need to work out a “true yield” or yield net of costs.

The landlord’s biggest cost is likely to be the mortgage. After that they should also allow for the substantial ongoing costs of maintenance, insurance, ground rent, service charges and a plethora of other add-ons such as lettings agent’s fees or advertising the flat if they do it themselves, getting a third party to undertake an inventory and so on.

Putting the mortgage aside, the insurance and maintenance could easily gobble up 15pc of the year’s rent. Using a traditional lettings agent could take another 10pc, pushing the costs to 25pc.

Now factor in the mortgage. Since most landlords favour interest-only loans, where the capital sum is not repaid, monthly outgoings are lower than for ordinary mortgages. Say the landlord looking to buy the £500,000 flat has a 40pc (£200,000) deposit. He borrows the remainder interest-only at a rate of 4.5pc. That costs £1,125 per month.

The annual mortgage costs are therefore £13,500. Add another 15pc of the annual rent to cover the costs of maintenance, insurance and so on – if he’s letting it himself – and the costs are now above £20,000 a year. Annual rent, net of costs, comes to £24,000, giving a “net” or “true” yield of 4.8pc.

Now do the same calculation with an extra 10pc lettings agency cost included, and the real yield falls further to 3.9pc. That is still an attractive net yield.

But, as many professional landlords point out by way of warning, when would-be buy-to-let investors sit down to calculate net yields on this basis they may end up with a negative figure. In other words, an ongoing loss.

In recent years, despite rising rents, the increase in property prices has meant even gross yields have fallen below 4pc, and in extremely expensive areas lower still. A studio flat being marketed today in a desirable central London location for £525,000 attracts monthly rent of £1,500.

That translates into a gross yield of 3.9pc. If costs in this scenario are 25pc of annual rent, that leaves just £14,600 per year to cover the landlord’s mortgage. A £300,000 interest-only mortgage charged at a rate of 4.5pc would all but consume this cash. And if the mortgage rate rose to just 5pc, the borrower in this scenario would have negative net yield and be losing money each month.

Landlord Expert
By Landlord Expert November 18, 2014 14:39

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