Why are rental yields so important?
Rental yields are critical and probably the most important investment metric used by landlords investing in residential investment property. It is an indication of the level of return on a investment. You wouldn’t put your money in a savings account without knowing the APR – would you?
Calculating a rental yield
The rental yield is calculated by measuring the annualised value of rents as a percentage of the underlying capital value of the buy-to-let investment. So, a property valued at £100,000, generating an annual rent of £6500 would therefore have a gross rental yield of 6.5%. This gross rental yield is a useful starting point in calculating your potential returns and helps give a landlord a quck and easy metric by which to measure it against alternative property investments.
For example if you were lucky enough to have £100,000 in cash and invested it in a rental property; a 6.5% gross rental yield would appear to compare favourably with the current return on a cash deposit in a building society account.
However, gross rental yields don’t tell us the full story. Any landlord will tell you that, unfortunately, they don’t get to keep all the rent. Therefore a more accurate figure of the true cash return from the rental property is given by its net rental yield.
The net rental yield strips away the associated costs of generating the rental income. This might include any management charges, such as: letting agent fees, ground rent, service charges, repair costs and insurance charges. One cost that is excluded from this is the finance charges associated with any buy-to-let mortgage.
Calculating a net rental yield
An examination of my most recent tax return shows that my expenses come in at around 16.5% of my total rent. This is despite the fact I manage my properties myself. Therefore applying this figure to my previous example would mean that the gross rent of £6500 becomes a net rent of £5427.50. This results in the gross rental yield falling from 6.5% to 5.4%. A rule of thumb is that the net rental yield is between 1-2% less than the gross figure.
Where to get rental yield information?
I’ll be honest, there is a dirth of decent quality rental yield information. I’ve been calling for some time for some decent national rental yield information for buy-to-let properties.
Having said that, there are a number of sources for rental yield information that can be used by a landlord . I’ve found home.co.uk which has a rental yield heat map which is interesting, although not entirely decipherable, it does show up the ‘rental yield hotspots’ by postcode.
Another source of rental yield data is Paragon Group. They have been compiling figures for several years. Their figures currently suggest rental yields are 6.3% across the UK, which sounds about right. They also reflect an expected variation of residential investment yields across the country, with landlords in the East Midlands achieving a 7.5% gross yield, compared to only 6.2% in the West Midlands. It appears that their data is derived from a market research company BDRC Continental which have a panel of landlords. I’m guessing that its a relatively small sample size, so this will limit the accuracy.
My gripes on rental yield information
Rental yield data is often used in articles by jobbing journalists who really don’t understand what it is, or how to calculate it. Often their only goal is to use the data to lead to some headline grabbing title like – ‘rental yield hotspot.’ It’s probably best to ignore these headlines as misleading media clap trap.
For a start, I frequently see journalists bundling rents in with the capital growth of the property ( increase in the property’s price ). This is simply wrong. Yield reflects the recurring revenue stream from an investment. Measuring the relationship between a income producing asset and it’s underlying value. It’s not helpful to bundle the two together.
London rental yields
There are several useful sources of rental yield for the capital. The first from a real time listing site London Property Watch gives a rental yield assessment.
If you are looking for a set of data verified by academics then the upmarket letting agent John D.Wood has a lot of information on posh central London areas.
Property Auction yields
Another useful source of data on residential yields is from auction houses who often sell high numbers of rental properties. These yield figures might tend to be on the high sidebecause often the properties are distressed or fire sales. The sale values can therefore be below what a landlord may get in a normal private treaty sale. However, the fact that the prices and yields are actual sale prices and not just asking prices gives them added credibility. The Essential Information Group release quarterly information on residential auction results which contain very interesting information on properties subject to Assured Shorthold Tenancy agreements. Latest results on residential investment yields released in their Residential Auction Property Investment Data (RAPID) This gives a useful national auction perspective on rental yields of property being sold at auction but comes out infrequently.
A more regular update of rental yields is provided by Allsop, who provide a summary of the average yields on investment properties sold with an Assured Shorthold Tenancy.
Investment Property Databank (IPD) produce residential rental yields relating to corporate buy-to-let property rented out by large institutional investors. In its 9th year, it measures net income and expenditure on assets. It allows investors to draw like for like comparisons with returns from commercial property and other asset classes. Again their figures show a large variation in rental yields across the country. Northern England is shown to have the highest gross rental yield of 7.2% for the latest year that figures are available in 2008. This gross rental yield illustrates even with recent house price falls how far rental yields have fallen from the start of the millennium. In 2001 gross yields in the North and Scotland were 10.1% and the average for the UK was 7.2% compared to 5.2% in 2008. The lowest gross yields were in Central London with 3.8%. The IPD residential yields index is the only one to show net yields, with rental voids and deductions factored in.
The source of irrecoverable operating costs are broken down into their constituent parts including costs of management, service charge expense, maintenance, utilities and write offs. The result of these deductions can be quite considerable. For example Net yields for Central London property in 2008 fell to 2.5%. The highest net yield for this year in the South East was infact only 5%.
Historic rental yields
A recent conversation with my accountant highlighted another aspect of rental yields – time. He was toying with the idea of selling one of his own property investments currently rented for £550 per month. He had been advised by an estate agent that he should be able to obtain about £120,000 for the property. This means that his current gross rental yield was 5.5%. Not fantastic but ‘kind of acceptable’. However, it turns out that he had bought the property 10 years ago for £80,000. This meant that his historic yield was a wapping 8.25%. Now that’s more like it.
Lies damn lies & rental yields
Technically, historic yields are not that useful. By using past values of an asset it does not really allow a landlord to compare directly the opportunity costs and returns from their property investments with other current investment opportunities.
However, it’s a useful metric for individual landlords to measure their own investment returns on their properties. As I mentioned previously you may choose to ignore rental yields when making your investment decisions. The property you choose to buy or invest in could be simply one that you inherit, or just because it is convenient to manage, or you think you or one of your family might want to live in it one day. This is all fine, but make sure that you do understand the basics of rental yields too. That way you have a little bit of an insight on where your money is going, even if you choose to invest for other perfectly legitimate reasons.
What is a good rental yield?
Clearly the types of rental yield that a landlord should be looking for will depend on the type of investment property they are looking at, and where they are looking to buy. As a rule of thumb and in the current low interest environment I would say a landlord should be looking for a gross yield of about 8%.
This should roughly translate into a net yield of about 6% by the time expenses are taken off ( insurance, voids, deductions). In the case of properties which demand a higher amount of management time, such as Houses in Multiple Occupation ( HMOs) then this figure should be considerably higher. I would suggest more like 12% as a national average.
The general rule with single lets, is the larger the property the lower the relative gross yield. Therefore, nationally a large house is likely to generate a yield of several percent below the average. Conversely, a studio flat is likely to potentially draw in a higher yield. Central London will have the lowest yields as will prime property location anywhere in the country. If a landlord is looking a purely income and prepared to look purely for a cash cow, it should be entirely possible to obtain a gross yield above 10%. With rents once again rising and property prices looking as if they may remain depressed for some time, landlords needs to switch focus to rental yields and not property price increases.
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