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How to calculate a property rental yield

1 - Theory

Calculating property investments rental yield can be confusing for us at the best of times. There are so many different theories on investments and what kind of returns you should be getting from your rent. They vary from calculating deposits into a property, and monthly returns, or just monthly mortgage payments offset against rental income. Some investors have interest only mortgages, and some do repayment, this can also vary the calculations.

Mostly people calculate property investing in a Yield format, taking the amount of money paid out on an investment, i.e. the monthly mortgage payment, and then taking away how much profit they make on the money they have paid into it, using the rental income after costs to get this figure. Once they have this figure they work out a percentage of what was paid in, to what they gained as profit, and this will be their rental yield.

You should how to calculate property yield if you want to be a successful property investor. The first thing you need to understand when dealing with investment property is that there are two types of yield - gross yield and net yield. These are the main types of yield to calculate if a property investment will be profitable.

Net yield also takes into account all operational / business costs (after subtracting all expenses, such as commissions, costs of purchase, and taxes), making it more reliable for a true assessment as to whether an investment project is likely to be profitable or not.

2- Area Variations

All across the UK we have varying property prices. In the South we tend to have higher purchase prices than the North. At the same time the rents are higher in the South also. Although the rents are higher in the South, they do not always compare favorably against the mortgage payments.

Lets compare 2 typical examples, based on some property I have looked at in the past.

2 Bed house in Manchester.

May cost £40,000 to purchase (around 2002), leaving you a £34,000 mortgage after paying in your 15% deposit, monthly payments of approximate £140. Rent could be around £350 a month, leaving you around £175 profit after agent fees of 10%.

2 Bed house in East London

May cost around £140,000, leaving you a £119,000 mortgage with mortgage payments of around £495 per month. Rent could be around £600 per month, and after agent fees of around 15% you would be looking at a profit of about £15.

3 - Equity V Cash flow

So look at both of the above investments again.

The Manchester property has about £6000 tied up in it as equity, this was placed as a deposit as lenders will give you around 85% loan. It is making a positive monthly cash flow of around £175. The East London property has £21,000 tied up in it, and is making less profit per month, around £15 if your lucky, although it may have a slightly better chance of growth being in the South. This essentially means that the Manchester property has a higher return on the money put into it as equity, and is giving a much better cash flow. Its chances of growth may not be quite as high, but there is certainly the potential for the North to catch up with the South eventually. If you were to take the £21,000 out of the East London property, selling it, you may even consider to buy 3 of the Manchester style property, and aim to achieve £525 positive cash flow per month.

4 - Other Theories

Rule of 12. One theory I read on a discussion forum many moons ago is the rule of 12. Basically advising you to knock of the last two zeros from the end of the purchase price, giving you your supposed rental figure. So take a property on the market for about £100,000, knock off the two zeros leaving you a rental income of £1000 pcm. I find this to be far to generic, as we all live in different areas, and have different ratios to what rents you can get for the type of property you buy.

Rental Growth. Some other theories out in the property world don't seem to stack up in all areas and regions either. Take the fact that rents are supposed to rise with salary increases. They don't always keep up, as rent prices really follow the demand factor. If there are lots of properties available then your rental price may drop, if there are few, it may rise.

5 - Personal Preferences

Property investing is all down to personal preferences and affordability. If you only have £6000 as a deposit, you may have to look at a property in the £30,000 - £40,000 price range (again based in 2002). If you have say £50,000 you may be able to afford something in a higher bracket. What you need to remember in all seriousness is to look for high rental demand and a comfortable return, nothing else. You don't want to be responsible for bringing down rents in an area you have just bought, damaging both yours and fellow investors nest eggs. Ignore theories, they will have you running in circles, and you may even end up turning down a good investment, just because someone else said it wasn't for them.