Understanding how to calculate the rental yield for a property is an essential skill for property investors. Rental yield is an important metric that helps you to work out the potential return on an investment property. We have created this guide on how to calculate the yield on a rental property to provide you with the tools and knowledge you will need to make smart investment decisions.
Before we get into the ins and outs of how to calculate rental yield, it’s important that we first understand what it means within a property investment context. Rental yield is usually expressed as a percentage that shows how much money you can expect to make from an investment property through rental income. This is the all-important metric that helps you to assess the profitability of such an investment.
This is why rental yield is so significant in the field of property investment:
Investment Assessment
Rental yield helps you to assess quickly whether or not a property is worth investing in. It can help you to work out which properties can generate a positive cash flow and which might not be such a financially sound investment.
Comparison Tool
Rental yield is a helpful indicator of whether the risks associated with an investment property are worth the rewards. This will help you evaluate multiple properties and select the ones that will give you the best return on your investment.
Risk Assessment
A rental yield can be a good way of conducting a financial risk assessment on a potential investment property. A higher yield can be a sign of a high level of risk, whereas a lower yield could suggest a less risky but more stable long-term investment.
Before you can whip your calculator or spreadsheet out, we must look at the two popular ways of how to calculate rental yield. These are:
Gross Rental Yield
Gross rental yield offers a simple calculation based on the yearly income of a property and its purchase price. The formula for gross rental yield is:
(Annual rental income / Property purchase price) x 100 = Gross rental yield
Net Rental Yield
Net rental yield gives you a more realistic idea of the rental value of a property, as it factors in other expenses associated with the property, including maintenance, management fees, taxes, and other costs. Here is the formula for calculating net rental yield:
((Annual rental income – Annual expenses) / Property purchase price) x 100 = Net rental yield
Here is a practical example of gross and net rental yields. Below are some figures that could represent real-world income and expenses associated with renting out a property.
Imagine that you have a property that gives you £20,000 in annual rental income. You bought this property originally for £300,000. The annual expenses, e.g. maintenance and management, are £5,000. So if we apply the calculations described above, we get these numbers:
20000 / 300000 x 100 = 6.66
Therefore, the gross rental yield on this property would be 6.66%.
Let us factor in the all-important annual expenses to work out the net rental yield.
20000 – 5000 = 15000
15000 / 300000 x 100 = 5
This gives us a net rental yield of 5%.
In order to get a realistic idea of rental yield for your property, you will need the following info:
Annual Rental Income
Find out how much you can receive in rent from the property in a year. To get an accurate figure, take a look at market rental rates on similar rental properties in the area.
Property Purchase Price
This is exactly what it sounds like, i.e. the total cost of acquiring the property. Remember to include any additional expenses like legal fees e.g. conveyancing, and other costs like stamp duty.
Annual Expenses
You can’t forget annual expenses when working out your rental yield. These can include property taxes, the costs of maintaining the property, building and landlord insurance, and other foreseeable expenses that the property might incur.
So, now you know how to calculate both gross and net rental yields for a potential investment property. This is a great first step, but for this knowledge to truly be valuable, you must know how to interpret the results in order to make an informed decision on the profitability of a property. Take a look below to get an idea of what rental yield percentages are considered high, standard or low. Always bear in mind your own financial goals when thinking about whether a rental yield represents value.
High Rental Yield >5%
Anything above 5% is considered a high rental yield, which for you could be a potentially great investment. It’s always recommended to investigate further and make sure there aren’t any catches or hidden costs that could cut into your rental yield.
Standard Rental Yield 3.5-5%
Anything between 3.5 and 5% is the standard rate for most UK properties and indicates a fairly common level of rental income. Always remember to look into the property’s potential for appreciation, deterioration, and the long-term stability of the local property market before investing.
Low Rental Yield <3.5%
Anything below 3.5% is considered to be a low rental yield, which could mean that the property is overvalued, the rent being charged is too low, or the annual expenses are too high. Always be cautious with low rental yields, although bear in mind that other factors may increase the value of the property in time, like local regeneration projects or overall property values.
There are plenty of internal and external factors that can affect the rental yield of a property, and it’s important to be aware of them when considering investment. Here are a few factors that you should think about before taking the leap to investment:
Location
This is always a big consideration that cannot be ignored – after all, the property isn’t going anywhere, so the location is always going to remain the same. However thanks to changes in the local economy and investment in the area, the location can become very different in the long term. Properties in popular high-demand areas can command higher rental values, giving you a better rental yield.
Property Type
From flats and terraced houses to larger detached homes and even commercial properties, there is a huge range of property types which have a significant effect on your rental yield. Obviously, a small flat will not command the same rental value as a large 4-bedroom house, and a large commercial property for business use can command even more. Always bear in mind though, that larger properties will have much higher expenses.
Market Conditions
Fluctuations in the local and national property markets can have an effect on rental income and the value of the property, both of which can affect your rental yield. Keep yourself updated on market fluctuations and seek expert advice from someone well-versed in the local property market.
Property Management
The way a property is managed has a huge effect on the rental yield. What you want is effective property management at a reasonable price for maximum rental yield. The last thing you need is inadequate property management, which can lead to reduced rental income and increased potential costs for you. Conduct diligent research and find an experienced and trustworthy property management company that will protect your investment.
Remember to keep checking your rental yield, as it can change over time due to increased costs, changes in rental income and other factors. This will enable you to make adjustments to maximise your rental yield, like regular rent reviews, reducing your expenses where possible, and changing the type of rental property to include students or even converting the property into an HMO (house of multiple occupancy) to boost your rental yield.
We hope this article has helped you discover why and how to calculate rental yield, equipping you with the tools you need to make the best investment decisions.
Interested in learning more about property investment? Check out our FREE property training to hear direct from our property and business experts here at Assets For Life. Learn more
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