If you are looking to purchase a rental property, it is important to understand how to work out the yield. Working out rental yield will help you determine if the investment is worth your time and money.
If you’ve ever wondered how to work out yield on a property, this article will help clear up a few of your questions. Here we will explain what rental yield is and how to work out yield. We will also provide an example to see how it works in practice.
Let’s dive in and find out how to work out the yield of a property.
How To Work Out Yield On A Rental Property
How To Work Out Yield On A Rental Property
If you’re thinking of becoming a landlord, you’ll need to know how to work out yield on a rental property. This is essential in order to determine whether or not the investment will be profitable.
The first step for working out rental yield is to calculate the gross annual income from the property. This is simply the total rent that you will receive over the course of a year. Next, you’ll need to subtract any operating expenses, such as taxes, insurance, and repairs. This will give you the net operating income.
Now, divide the net operating income by the property’s purchase price. This will give you the capitalization rate, which measures the property’s profitability. Finally, multiply the capitalization rate by 100 to get the percentage yield. For example, if the capitalization rate is 0.1, then the yield is 10%.
As you can see, it’s not too difficult to calculate the yield on a rental property. Just remember to factor in all of your costs before making your final decision.
There is another method to do this, which is working out the gross yield. In this calculation, the only numbers you need are the annual income from the property and the purchase price. With gross rent yield, you don’t need to include any expenses.
Out of the two, gross yield is the more commonly used figure. While that is true, net yield can still be useful to see how much your expenses are affecting any potential profit.
Examples Of How To Work Out Yield
For these examples, let’s say you purchased a property for £180,000 and intend to charge £750 per calendar month.
Gross Rental Yield
12 x £750 = £9,000
£9,000 ÷ £180,000 = 0.05
0.05 x 100 = 5%
Net Rental Yield
Annual Property Costs (Including Mortgage) = £6,000
12 x £750 = £9,000
£9,000 – £6,000 = £3,000
£3,000 ÷ £180,000 = 0.017
0.017 x = 1.7%
What is a Good Rental Yield?
So now you know how to work out rental yield, it begs the question what is a good gross rental yield? This can depend on a few factors, but there is a general line of thinking in place.
Awful = 0-2%
At this level, it would not be worth investing in the property. If this is your current property’s rental yield, you may want to consider selling the property or increasing the rent.
Bad = 2-4%
This isn’t a great yield, but it should give you a decent monthly profit. This could be that your rental income is too low, or perhaps you had to pay an inflated purchase price.
Good = 4-6%
Ideally, this is where you can expect to be. Here you’ll be getting a great monthly profit, which would be a good investment.
Great = 6+
Any rental yield above 6% would be fantastic. This is usually the result of finding a property that was under market value when you bought it, at an auction for example, or perhaps it’s a property you had to renovate.
If you’re wondering what a good net rental yield is, then there aren’t any set standards for that figure. A good gross yield means you’ll almost certainly have a good net rental yield. There can be huge differences in net rental yield, such as if you need to pay a mortgage or not.
Due to these factors, net rental yield isn’t generally considered when working out if a property is a good investment.
Who Uses The Rental Yield?
Rental yield can be used for a wide variety of reasons, here’s who would be most interested in this figure:
Buy-to-let landlords
For those renting out a property they don’t have a mortgage on, the yield isn’t as important. This is because you can be assured of a healthy monthly profit as your monthly costs are going to be very low.
The yield becomes very important if you’re looking to buy a property to let. A mortgage company will also use this figure when considering your application.
New landlords
Even if you’re not buying to let, the yield can still be an important consideration. It can let you know whether it’s better to sell your property or let it out.
Letting agents
Your letting agents may also use your yield when working with you. It can be important in working out whether using a letting agent would be a good idea or not.
Current Value or Purchase Price?
When working out rental yield, you can either use the price you paid for the property or its current value. Of course, this may be the same for many new landlords, but for those who have had a mortgage for a while, it may be very different.
The general rule is to use the purchase price. This is because it’s the figure you actually paid and what your mortgage was based on. This will give you a clear idea of whether or not your property is a good investment as opposed to the ever-changing value figure.
As we mentioned, the rental yield is less important if you either don’t have a mortgage payment or your mortgage is minimal.
For example, if you bought your property 15 years ago and have low monthly mortgage payments, then renting your property will almost certainly give you a sizeable monthly profit, and using the current value may be deceptive.
In this scenario, if you are working out the rental yield on the purchase price, you’ll be working out property market value from 15 years vs rental market value from today. Due to this, using the current value may show that you have a low yield when, in fact, you’ll be making a large profit per month.
Let’s look at an example of why using current value often isn’t useful.
Current Value: £300,000
Purchase Price: £150,000
With a monthly rental cost of £750, with the current value, you’d have a gross yield of 3%, and with the purchase price, it would be 6%.
Here using the current value would be deceptive as you’d have low or no mortgage payments, and therefore excellent monthly profit. Even though the 3% figure isn’t seen as a great yield, your low monthly expenses would mean that it would still be a good idea to put your property up for rent.
Due to all these factors, we can see that 1) it’s better to use the purchase price and 2) the rental yield is less useful the longer you’ve owned a property.
What To Include In Net Yield Calculation
We’ve seen that gross yield is the more commonly used figure, but the net yield can still be useful. When working out rental yield, it’s important to include all of your expenses, these include:
Mortgage
This is by far the most significant cost for many. A high mortgage may even mean that your net yield is negative.
Repairs and maintenance
Rental properties, as with any property, constantly need repairs. These all add up, and it’s important to track all of them.
Bills
As a landlord, you can decide whether the tenant or yourself pays the household bills. If the latter, then they should be included in the net rental yield.
Ground rent/service charges
Depending on your property type, you may need to pay ground rent.
Insurance
Insurance is important for any landlord and should be included in your calculation
Letting agency fees
This can be a significant expense, but for many landlords, it’s worth it for a more stress-free life.
Miscellaneous costs
Any other miscellaneous expenses should also be added.
How Much Monthly Profit Should You Make On A Rental Property?
For many people, there is a standard rule for the profit you should be making, and that’s the 1% rule. That is, you should make 1% of the purchase price in profit per year.
For example, if you bought a home for £150,000, you’ll want to have at least £1,500 in profit per year. However, if you have a low or minimal mortgage on the property, then you’ll be aiming to make more than this.
Another commonly used figure is that you’ll want a minimum of £150 monthly profit. If you have a high gross yield, then it’s highly likely that you’ll be making this type of profit, at least.
Final Thoughts
Working out rental yield is a pretty straightforward, but heavily important figure to get right before you start investing money into a property. Gross rental yield is fairly easy to work out as it’s your yearly rent total, divided by your property purchase price and multiplied by 100. This will give you a percentage figure, and anything above 4% is generally considered good.
However, we’ve seen that many factors can affect the rental yield on a property, so it’s also important to take them into consideration before deciding whether or not a property would be a good rental investment.