If you are thinking about becoming a landlord with a buy-to-let property, it is
important to understand what rental yield means.
This handy guide will explain what rental yield is, how you can calculate it – and how you can drive it up as far as possible.
Rental yield is a measure of the return on a property investment. There are many
factors that can affect rental yield, including property prices, interest rates, rents, and tenant demand.
Gross rental yield
You can calculate gross rental yield by dividing a year’s total rent by the purchase price of the property and multiplying by 100.
For example, if you bought a buy-to-let property for £400,000 and receive £1,500 a month in rent, to give an annual rental income of £18,000 (12 x £1,500), the gross rental yield is:
(18,000 / 400,000) x 100 = 4.5 or 4.5%.
However, while gross rental yield might be a simple calculation, it does not take into account any costs, such as mortgage repayments, insurance or upkeep of the property – and these need to be considered to judge whether letting the buy-to-let property is providing a good return.
Net rental yield
Net rental yield is often a better measure to use than gross rental yield because it takes into accounts the cost of owning the property, including any outstanding mortgage repayments.
Net rental yield is calculated by taking the annual rental income minus costs
associated with owning the buy-to-let property. Then, depending on which definition of net rental yield you wish to use, it can be divided by either:
a) the property value
b) the initial capital outlay on the property (ie. the full amount less what has been borrowed through a mortgage)
If you bought a £190,000 property with a £140,000 buy-to-let mortgage at a fixed interest rate of 3.44%, your interest repayments will be £401.33 monthly or £4,816 annually.
If you set the monthly rent at £800, the annual rent collected will be £9,600.
Typical annual costs for insurance (£360), essential repairs (£900) and void periods (£800) add up to £2,060.
This means the net rental income will be £2,724 (£9,600 – (£4,816 + £2,060)), with the net rental yield being (2,724 / 190,000) x 100 = 1.43 or 1.43%.
The first part is the same. You buy a £190,000 property with a £140,000 buy-to-let mortgage and annual repayments of £4,816. You also collect £9,600 in annual rent, but other costs each year tot up to £2,060.
The net rental income will be £2,724, but instead of dividing this figure by the
property value, we instead divide it by your capital outlay. ie. £50,000.
This returns a net rental yield of (2,724 / 50,000) x 100 = 5.45 or 5.45%
The examples demonstrate how the true returns of buy-to-let are whittled away when you take into account the overall costs.
Rental yields vary depending on factors such as the current mortgage interest rates, taxes and reliefs available, and fluctuations in the property market. But there are steps you can take to maximise your rental yield.
1. Increase the rent
If the rent you have set is lower than the market rate, you may be able to increase it. However, you will need to ensure that this is permitted within the Assured Shorthold Tenancy Agreement. Lane & Browns have an annual rent increase clause. You should also not underestimate the worth of reliable long-term tenants who take care of your buy-to-let property. The loss of income incurred by just one vacant month could take two years to recoup through a rent rise.
2. Cut the rent
It sounds like a contradiction in terms, but if the rent is too high versus the property or the area, lowering the rent can ensure you don’t miss out on rental income due to void periods.
3. Utilise your tax credit
Since April 2017, a new buy-to-let tax system has been gradually phased in. It
means that since April 2020, you cannot deduct your mortgage interest
payments from your rental income when calculating what tax you owe. Instead, all of your rental income will be taxed, and you’ll qualify for a 20% tax credit for your mortgage interest.
4. Update the property
Expectations among the kind of tenants you want are higher than ever, so follow suit by putting in a good kitchen and bathroom. You will also be able to charge more rent.
5. Lower your overheads
This can mean anything from remortgaging to a better deal, to sourcing
cheaper plumbers or electricians.
While thorough research should help ensure your property investment is a success, like any investment there are risks. If your buy-to-let property is vacant for any period, then it could quickly wipe out any potential gains.