Rental yield calculator: what is your property delivering?
Understanding the gross yield and capital growth of your investment property is vital for all landlords. If you don’t know these figures you won’t know for certain if your rental property is working for you. And if you’re thinking of buying a new property, it’s harder to judge whether you should invest or not.
Our rental yield calculator can help you do this quickly and simply, so why not give it try now? Or, not sure where to start? Read on to find out what you need to know.
Why you need to understand the yield on your investment property?
As we’ve mentioned knowing your yield, capital growth, and also your buy-to-let return is important. If you don’t know your rental yield and capital growth then you can’t:
- Work out whether an investment property is worth it
- Compare how different property investments stack up
- Decide whether you should opt for a buy-to-let investment or an alternative form of financial investment
- Evaluate the risks of a buy-to-let investment
- Calculate the returns you can expect from your investment property
What is rental yield?
Rental yield is a way of working out the return on investment you get from your property. Yield takes the rental income you receive from letting out the property minus costs and places that figure against the cost of buying the property itself.
The final figure, usually expressed as a percentage, gives you your yield. Once you have this figure you can then compare potential properties to see which might be the best investment. You can also see if you might be more comfortable putting your money into investments outside the property market.
For example, if you could get a guaranteed annual gross return (yield) of 5% from putting £125,000 into a savings account, then you might prefer to do that. The upside of a guaranteed savings scheme is that, whatever happens, you will get that return.
If you invest in a buy-to-let property that is projected to yield a similar return, then you need to be aware that this figure isn’t set in stone. It can be reduced by market forces or when the property is empty and not earning you any rent.
But, buy to let does have the potential to gain capital growth, while guaranteed savings account doesn’t. Find out more.
Calculating rental yield
There are several different ways to go about calculating rental yield. To some extent, as long as you’re consistent, it doesn’t matter which method you use.
The most popular way of working out yield is to take your annual rental income (actual or predicted depending on if you own the property or are looking to buy) and divide it by the purchase price of the property, like this:
- Annual rent: £8,000
- Property purchase cost: £125,000
- Gross yield: 6.4% (£8,000/£125,000)
What is a good rental yield?
Like anyone making an investment, you want to know if it’s a good one. That is subjective to some extent. For instance, when it comes to investing in property, a lower rental yield can be offset in the mid to long-term by capital growth. But it makes sense to ask yourself: what is a good rental yield.
A good rental yield is one around the seven per cent mark. If your rental yield is above seven per cent then you’ve got a very good yield from your property.
What is capital growth?
Capital growth is the profit you have made on the investment property. It’s measured by looking at the difference between the property’s current value and its value when you first purchased it.
Knowing the capital growth on your property is important because you can use it in conjunction with the gross yield to compare how different properties you own have performed. Then you can work out your total returns, which will allow you to more accurately compare buy-to-let property returns against other investments.
Calculating capital growth
Calculating capital growth is very simple. You take the value of the property today and deduct the amount you paid for it, for example:
- Property purchase price, 10 years ago: £80,000
- Current property value: £150,000
- Capital growth: £70,000 (£150,000-£80,000)
It’s that simple. However, it’s important to get this figure pinned down to really understand your property’s performance.
Work out your buy-to-let return
Your total buy-to-let return is calculated by adding the capital growth return to the rental income return over the same time period. This is usually expressed as percentage: For example:
- Property purchased in 2002 for: £125,000
- Valued 10 years later in 2012 at: £150,000
- Capital growth is: £25,000
- Capital growth return is: £25,000 ÷ 10 years = 2.5%
You then need to calculate your rental income (the money the tenant pays when you let the property to them) over the 10 years you’ve owned the property.
So if you’ve earned £60,000, then your rental income return is £60,000 ÷ 10 years = 6%.
So, your total annual buy-to-let return is 2.5% + 6% = 8.5%.
If you compare this with a savings account that gives you a guaranteed 5% annual return, the buy-to-let investment looks better. However, you do need to balance the risks of putting the money in a savings account versus investing your money in an investment property.
With a savings account the return is guaranteed, typically annually or at the end of a fixed term. On a buy-to-let investment you’ll typically need to tie up your money for 15-20 years to secure a good return versus other investments.
Your buy-to-let return can also vary from one year to the next. For an extreme example, rents dropped by up to 20% between 2008 and 2009, and property prices for the first five years after the credit crunch also dropped by up to 20% - more in some areas.
Because buy-to-let returns aren’t guaranteed, property is considered higher risk than simply putting money in a savings account.
Understanding rental yield, capital growth and your buy-to-let return is just the first part of learning to compare property investments. When working out your objectives or investment returns for tax purposes you’ll need to do more complicated calculations. This means understanding net yield and HMRC’s definition of capital growth from a property tax perspective.
If you’re moving into buy to let, one way to help safeguard your investment is to have the right landlord insurance. This way you can cover your liability as a landlord and make sure your property is insured for the risks of running a rental.