If you are thinking of investing in property, you are probably looking for one of two things: a regular income (rental property yield) or for the value of the property to increase over time (capital growth). You may even benefit from a combination of them both.
There have been plenty of changes to the rules around buy to let over the past few years, not least the 3% stamp duty surcharge on second homes, making it appear a less lucrative prospect than it once was.
However, with interest on savings accounts incredibly low, property investment can bring you a much better return.
The key is being careful about where you invest, focussing on the most popular areas you can afford – these are more likely to attract tenants and grow in value, long term.
When weighing up a property investment, calculating its rental yield is key. If you’re wondering how, we help you do the maths to see whether a buy to let property might be a good investment.
What is rental yield?
Rental yield is a property’s return on its purchase price expressed as a percentage.
How do I work out rental yield?
To calculate your buy to let investment’s rental yield, start by taking the total rent received over a year.
The average rent for a property across London is currently £1,600 per month, which adds up to an annual rental income of £19,200.
Next, take the purchase price of the property (again let’s use the average cost of a flat in London, currently £450,000).
Add to that the costs that come with buying, the main one being stamp duty. As a second home, you’re buy to let will attract the 3% stamp duty surcharge. Using the HMRC stamp duty calculator, the tax payable on this property would be £26,000.
Add an estimated cost for professional fess of £2,000 and you have a total cost of £478,000.
Now perform the calculation: 19,200 ÷ 478,000 x 100 = 4%.
What if I’ve taken out a mortgage?
This calculation above assumes the property investment was purchased outright, without the need for a mortgage.
To work out your rental yield, taking a property loan into account, your annual mortgage costs should be subtracted from the £ 19,200 received in rent.
Say you took out an interest-only, buy to let mortgage for 75% of the purchase cost (£337,500) at a rate of 3%. Your monthly mortgage payments would be £1,150, or £13,800 per year.
Subtracting that figure from the annual rent of £19,200 leaves a pre-tax profit of £5,400 per year.
To calculate the yield, take the deposit you put down (£112,500) and add that figure to the buying costs (£28,000). This gives a total of £140,500.
Now perform the calculation: 5,400 ÷ 140,500 x 100 = 3.8%
You can also use a rental yield calculator to help you work it out, such as this one on the Which? website.
What is a good rental yield?
Most commentators regard a rental yield of 7% or more as a good return on your property investment. In this example, even the 3.8% yield, if the property is mortgaged, is higher than the interest you’ll receive from a savings account – the best, easy-access rates available are currently around 1.4%.
What about capital gains?
Uncertainty over Brexit meant London house prices have been stagnant or falling in some areas. However, the stability brought by the general election result has led to signs that the market is improving, according to some commentators,
People will always want to live in London, and history has shown that prices usually rise over time, but you may need to be prepared to hang on to your investment for 10 years or more.
What else should I consider?
Bear in mind that a landlord’s true income from a buy to let investment is the amount of rent left over after all the other expenses associated with the property have been met. These can include covering void periods, maintenance costs, landlord insurance and the fees charged by letting agents.
Remember too that every buy to let investment is different and the rental yield you achieve will vary depending on the cost of the property and the rent you are able to charge, as well as other factors. For this reason, the figures quoted above are for illustration only.