Introduction
Rental yields are the figure most investors use to determine what a good investment is based on rental income as opposed to alternative investments.
As a landlord, you want to make sure you are getting the most out of your rental properties by understanding rental yield in detail. All will be discussed in this article.
What is a good rental yield?
The question ‘what is a good rental yield?’ is strictly dependent on where in the UK your property is located. A property in the City of London will have a dramatically lower rental yield than the yields in a UK city like Doncaster for example.
So, determining what a good rental yield is will depend on the market of the location, interest rates as well as the value of a property. It is improper to believe that the higher the yield of property the better investment it is.
This disregards the other piece of the puzzle – appreciation. Not all investors choose to solely rely on rental yield but also rely on property appreciation to make a return on their money.
What is rental yield?
Rental yield refers to the net rental income as a percentage of the value of the property specific to the profit on the rent you are making. This means subtracting all of the expenses of a property such as home insurance, gas bills and mortgage payments, only using the net rental profit in the calculation for yield.
Calculating this figure is mandatory for those looking to make an investment such as landlords buying buy to let properties or investing in a build to rent development. However, this figure isn’t the only figure available to calculate the overall assessment of expected returns.
There are also figures like Return on Capital Invested (ROCI) which is sometimes considered more accurate to gauge a return. This figure uses the amount of money you currently have in the property deal (as a deposit for example) rather than the overall return on the value of the house.
ROCI can be used to see the direct comparison between keeping your money elsewhere such as in a bank or the stock market. Investors can then use this figure to weigh it up with the level of involvement they’ll have in the property, the risk they’re taking on and their desired return to make a decision that’s right for them.
It is important to note ROCI nor rental yield can be calculated accurately until there are tenants in the property and all costs have been accounted for so landlords will often use one or both figures as an estimate to make the best decision.
In general, both of these figures will be calculated by a lender before they give out a mortgage as part of a valuation survey. So, to find out what they are you may want to ask the bank for some advice.
What is a good rental Yield for London?
In parts of London with high property value, a good rental yield is around 2%. However, in boroughs where house prices are cheaper and generally property appreciation is lower, a good rental yield can be up to 4.7%. This table shows the difference between boroughs.
All in all, London rental yield is still considerably lower than the rest of the UK. In fact, London has the lowest rental yield of any major UK city.
What are the average rental yields in the UK?
3.63% is the average rental yield in the UK. This figure is a good reference to go by, however, looking at average yields for areas you are most interested in investing in would be the best way to get an accurate figure to compare to.
Average rental yields across the UK as of 2022 have gone down in recent years because of an increase in house prices. This happens because yields are calculated by taking the rental profit as a percentage of the overall house value.
Because of this dip in yields, investors must remain versatile by investing in the most profitable areas or perhaps transitioning into longer term investments like build to rent developments which are shown here to be less dependent on the economic climate.
What are the best cities for rental yields in the UK?
Some cities in the UK have significantly higher rental yields than London as discussed. Popular choices for investors looking to take their buy to let investments out of the capital include Hull, Glasgow and Stoke. The rental yields in these areas boast an impressive 9.2%, 9.1% And 8% respectively.
Why Rental Yield Matters
Rental yields matter because if you don’t produce a profit from your rental income as a landlord, the only other way to make your money back is on the re-mortgage of a property when and only if the property goes up in value.
Solely relying on a property’s appreciation is a risky game because of things like stamp duty and land tax or Land and Building Transaction Tax in Scotland eating into your profits when you buy a property. Also, capital gains tax may be applied when you sell.
Aside from the risk involved, buy to let properties are almost always used as an investment for landlords. So, it is a no-brainer to want to increase your earned income from your property investments. Calculating rental yield increases your chance of a successful investment and allows a landlord to make a sensible purchasing decision.
How does rental yield impact a property’s sustainability?
When buying a property you don’t intend to live in, but use for rental income, rental yield is used to assess a property’s capability to pay off a mortgage effectively. Lenders will typically look for rental yield to surpass mortgage payments by 120% – 125%. This figure allows a landlord to comfortably pay off their mortgage
This prevents landlords from borrowing money they’ll struggle to pay back. Incurring late mortgage payment fees and perhaps having their property repossessed by the lender.
For example, if the mortgage payments from the interest of a buy to let mortgage is 4%, the rental yield will have to be 120% – 125% in excess of this figure at 4.8% for the mortgage application to have a high likelihood of approval.
Costs Your Rental Income Needs To Cover
Rental income needs to cover all the expenses of your property and still have some income left over after income tax in order to produce a profit for the investor. This is common for landlords buying property for profit for example if they were buying a second home.
Some of these costs are able to be reduced by doing them yourself but typically, for an investor who doesn’t have time to deal with everything in a property, costs will include:
- Letting agent fees (Possible to manage yourself)
- Property management fees (Possible to manage yourself)
- Council tax and licences (Depends on the borough)
- Safety certificates
- Mortgage payments
- A building or home insurance
In addition, Landlords should have money saved in case there is a period of time when there is no tenant in the property. This is known as a void period which can be mitigated by purchasing rent guarantee insurance but is another expense.
How To Work Out Rental Yield
The term rental yield sounds quite sophisticated but is in fact very straightforward. You simply take the net rental income, divide it by the property’s value and multiply by 100. For more information, read more on how to calculate rental yields.
Who can use The Rental Yield Calculator?
Rental yield calculators can be used by anyone having properties as investments. You can come up with an estimated rental yield calculation before you purchase a property or you can do the calculation after you buy a house.
It would also be a good idea to revisit this figure over time as properties can appreciate in value but rents stay the same, driving down an investor’s rental yield. In this case, raising the rents can be done to increase the rental yield or remortgaging a property to pull out some equity for new investment can increase your overall rental income. This method allows you to buy a property with no money.
As an example, on the other hand, the increase in house purchases due to help to buy loans and new build property developments could increase home supply. When giving properties a valuation, as a result, property prices could dip, making rental yields increase.
Is 6% a good rental yield?
For most places in the UK, 6% is a great rental yield. However, if comparing 6% to some of the cities in the UK with the highest yields, this figure doesn’t stand out that much.
In addition, as interest rates rise to reduce inflation in a bleak economic climate, rental yields will need to rise quite a lot anyway in order to be approved for a buy to let mortgage. So, producing a 6% yield on a buy to let property may not be sufficient to pay back the interest rate on a mortgage even though it would be in the past.
Price, Yield and Growth. Finding the Right Balance
Yield has been discussed in detail but how does this relate to the price of a property? Well, if the property price goes up but the rents of the property stay the same, the yield of a property will drop. As a result, if landlords have lower rental yields, they will look for houses with higher values and for this value to go up over time.
If investors cannot make money in one way, they will find a way to do it in another and there is a constant delicate balance between capital appreciation and rental yields in this way that largely depends on the location of a property.
Ideally, investors would want to buy in areas of the UK that benefit from both capital appreciation and rental yield. A good example of this would be Stratford in 2012 after the regeneration of the area for the Olympics.
There was a huge demand for people to live in Stratford for the long term so house prices went up as people wanted to buy. Likewise, there was a demand for people to live there in the short term by renting so the areas had high rental yields.
This is why a property in the centre of London in Chelsea for example may be worth tens of millions of pounds and likely have a low rental yield of 1 or 2%. Landlords do not mind this low figure because the appreciation of the property compensates for the lack of rental income if they decide to sell it.
Is student accommodation a good investment?
Student accommodation is attractive for many landlords because of the clear demand for rent. Good universities like those in the UK are excellent indicators of high rental demand in the area. In fact, on average, the UK has the fifth highest rental yields for student accommodation in Europe but this figure largely depends on the city in the UK.
Conclusion
To conclude, rental yield is an important figure when deciding on an investment in a property for landlords and lenders alike. The figure differs largely on the location of the property and it is worth comparing between boroughs, cities and counties to get the best idea of what rental yield you should expect.
Before you embark on your next property investment, accurately calculate your yield using a calculator to figure out how well your investment will serve you as a landlord and to see if you’ll be better off just investing in your pension instead.
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