What is a good rental yield?
Rental yields have always been a critical metric when finding an investment property and they are key to any good investment decision.
What rental yields should a landlord expect?
The rental yield is the measure of the income generating capacity of a residential investment. There are two types of yield measurement. The gross rental yield is the simple relationship between capital value and the annual rent generated.
Take for example a £100,000 studio apartment generating a monthly rent of £600 or £7200 per annum. The gross rental yield on that apartment would be 7.2%. Gross rental yields are useful because they allow property investors to directly compare residential investments against each other using a simply generated figure.
When comparing returns against non property based investments it is more useful to use a net rental yield, which includes certain associated costs in the managing of the residential investment. The most obvious of these are: letting agent fees, landlord insurance costs and property maintenance costs. Taking these costs off your rental income will allow you to arrive at a net rental yield which will be a more realistic comparison against non property investments that don’t carry such costs, such as equities and bank accounts.
So if we look at the example above say the landlord paid 15% management fees to their letting agent or £1080 pa, £220 in insurance and £200 in maintenance costs or £1500 in total. The resulting net income comes down to £5700 pa or a net rental yield of 5.7%.
As a rule of thumb the difference between gross and net rental yield is between 1-2%. With returns even on the best bank deposits historically low most net yields compare very favourably.
Investment return becomes more complicated with the need for buy-to-let finance. Net income will therefore depend on the amount of interest paid on the buy-to-let mortgage. The variability of this between different landlords is the reason it is not used in the net yield calculation. The fact that the investment is geared will result in a much more complicated calculation to produce the estimated annual return. To get a fuller picture have a look at Property Hawk’s property investor appraiser.
Average rental yields
Getting hold of reliable residential rental yields is very difficult. Not since the Rowntree Trust produced an index of residential yields has their been reliable nationwide index based on actual rents achieved by landlords and the capital values of the property they invest in. Some of the larger property portals do produce rental yield indexes such as countrywide or findaproperty. These are useful in that they give some relative indicators between property types and areas along with a measure of rental yields over time.
However, they don’t always provide an accurate picture. Frequently their figures under estimate the real rental yields being generated by landlords. This is because they use general capital figures for housing in a specific area compared to rents generated in that area. However, they do not reflect the actual types and prices of property that landlords are investing in. Most landlords have a bias towards investing in properties generating above average rental yields by the fact they have a lower capital cost or generate a relatively higher rent.
What is a good rental yield?
As a rough guide the smaller the property the higher the rental yield. This means the highest self contained rental yields are produced by a studio property, with single room occupancy such as Houses in Multiple Occupancy (HMO) producing the highest of all.
The downside with an HMO is that your property management costs will be considerably higher because tenant turnover tends to be greater and the residential use is more intensive (more tenants using the same kitchen and bathroom). The result is that costs are higher as is the differential between the gross and net yield than that of a self contained property. Landlords should be aiming for a double digit rental yield for a HMO to justify the additional work.
As a rule of thumb you should be looking for a gross rental yield of around 8% outside London for a self contained studio or one bed flat. This kind of figure should also be achievable for terraced properties in some areas.
Semi detached and detached property rental yields will be lower at around 6-7%.
Yields in the best residential areas will almost always be lower than less affluent areas. Two reasons. Firstly the general assumption (not always true) that these properties will attract more responsible tenants i.e. doctors, lawyers, etc. Secondly, historically capital growth has been stronger over time in the best areas.
Rental yields & mortgage finance
The rental yield of a residential investment property is also often key in securing buy-to-let finance. This is because buy-to-let mortgage companies focus on rental cover when accessing a mortgage application. Many buy-to-let mortgage companies will look at a minimal rental cover of around 120-125%. This means that the rent generated by the investment must be a quarter to a fifth more than the mortgage payments. BTL lenders vary on how they apply the rules. Some will make a deduction from the rent for letting expenses and others will only count interest payments and disregard any capital repayments.
For more details on the assessment criteria of specific mortgage companies contact Property Hawk Mortgages for FREE expert advice.
Current trends in rental yields
The trend for rental yields is up as rental shortages push up average rents whilst the weakness in the housing market continues to depress capital values.
This is all good news for landlords as the potential rental returns on their investment continue to rise. It also reinforces what all seasoned property investors already know. Rental yields are key to making a good investment and should always be the starting point in evaluating any potential buy-to-let investment.
What rental yields should landlords be aiming for in the current market?
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