When buying rental property it is important to know how to calculate the returns your investment will make. Below we will discuss and demonstrate some of the most common calculations and figures you’ll need to know. You should always do a quick appraisal of any investment before you go ahead to make sure it is worth your while.
When calculating rental yield values you can also examine the effect that borrowing has on your potential returns, such as between buying a property in cash and using a buy-to-let mortgage to fund the purchase.
How much you decide to borrow also depends on your attitude towards risk, as we all know that interest rates can go up as well as down. It’s really a matter of personal preference and how you see the local economy and cost of borrowing for the future that should influence your investment decisions.
A simple rental yield calculation
Lets say that you purchase a property for £100,000 and you receive rental income of £500 per month from your tenant.
The yield calculation would be as follows:
£500 x 12 = £6000 per annum rental income.
(6,000 ÷ 100,000) x 100 = 6% Yield
So simply put, Yield is the return on your investment expressed as a percentage of what you put in (i.e. If you invest £100,000 and you receive £6000 in income per year, so £6000 is 6% of £100,000.)
The above example does not factoring in any property maintenance costs (including safety checks), management charges and insurance, etc., and doesn’t include any mortgage payments.
Calculating yield with a mortgage & associated costs
Let’s say you purchase a property for £100,000 but this time you use a buy-to-let mortgage and have to pay for the property insurance and some maintenance costs.
The following are the figures we use to calculate the yield value;
Purchase costs: £1000 (including solicitors fees and insurances etc…)
Deposit at 25%: £25,000
Mortgage costs are calculated as follows:
A £100,000 property (purchase price) with a 75% LTV (loan to value) interest only mortgage at an interest rate of 5.0%.
£100,000 – £25,000 = £75,000 mortgage
Monthly repayments are: £75,000 x 5.0% = £3,750 per annum. £3,750/12 = £312.50 per month.
The gross profit would be;
£500 rent – £312.50 Mortgage = £187.50 gross profit per month
£187.5 x 12 = £2,250 per annum.
Now we have these figures we can now calculate the yield value as follows;
Amount invested so far is: £26,000 (deposit + costs)
Annual gross profit is: £2,250
(£2,250 ÷ £26,000) x 100 = 8.65% Yield Value on cash amount invested
Looking at these figures you could have bought 4 properties secured on a buy to let mortgages with a £104,000 (an investment of £25,000 in each plus costs of £1,000) investment and receive £9,000 in gross rental profits.
If you had bought 4 properties with buy-to-let mortgages you will own a larger amount of assets (£400,000) so you will also get greater capital gains if the house price was to rise in the future.