When looking at how to work out rental yield, this is to look at how to find the measure of the return on investment that a property owner can expect to receive from their rental property. It is calculated by dividing the annual rental income of a property by the property’s value or purchase price.
In this article, we will explain how to work out rental yield and why it is important for property investors to understand and monitor this metric. We will also go over how this figure relates to the capital appreciation of a property too.
How to work out the rental yield of your property?
To work out the rental yield of your property, you will need to calculate the annual rental income of the property and divide it by the value or purchase price of the property. The resulting figure is the rental yield, which is expressed as a percentage.
Rental yield example
Here is an example of how to work out the rental yield of a property:
Determine the annual rental income of the property by multiplying the monthly rent by 12. For example, if the monthly rent is £1,000, the annual rental income is £12,000.
Determine the value or purchase price of the property. For example, if the property was purchased for £250,000, the value is £250,000. Then, divide the annual rental income by the value or purchase price of the property. To work out rental yield, the figure would then be £12,000 / £250,000 = 4.8%.
The resulting figure when investigating how to work out rental yield represents the return on investment that the property generates through rental income based on the amount of equity that is in the property.
A higher yield indicates a better return on investment while working out a lower rental yield indicates a lower return on investment. It’s important to note that as you examine how to work out rental yield, it will only ever be an estimate. In reality, there are a lot of other expenses that can influence the statistic.
Some landlords like to work out gross rental yield and others prefer to work out net rental yield. However, working out net rental yield is what is generally more popular amongst landlords.
How to maximise your rental yield
There are a few methods you can do to maximise the percentage when exploring how to work out rental yield of a property. This is vital if you feel as if a property will not produce a profitable investment or gain approval for a mortgage.
Calculate the right amount of rent
Setting rent at the right price is crucial. This means charging a fair and competitive rent that is in line with similar properties in the area. It is important you use guidelines around charging fair rent for the area which you can find out more about here.
Nonetheless, if there are unique features or amenities that your property has, do not be afraid to charge for this. If you’re not sure what the rent you should calculate is, you could hire a letting agent to maximise the rental income of the property without pricing yourself out of the market.
A letting agent will have the incentive to rent out your property but will also want to rent it out for the highest rent they can if they’re on a commission structure.
Keep the property in excellent condition
A well-maintained property is more likely to attract high-quality tenants and command a higher rent even if the property isn’t actually that valuable. Regularly inspect and maintain the property, and make any necessary repairs or upgrades to keep it in good condition, especially when opening the property up for viewings.
Doing this will also reduce the complaints you may get if you have to issue a section 13 in a periodic tenancy to increase the rent of a property.
What is gross vs net rental yield?
As you discover how to work out rental yield you will find it will become a measure of the return on investment that a property owner can expect to receive from their rental property. It is calculated by dividing the annual rental income of a property by the property’s value or purchase price.
Gross rental yield is a measure of the return on investment that a property owner can expect to receive from their rental property based on the property’s gross rental income. It is calculated by dividing the annual gross rental income of a property by the property’s value or purchase price.
For example, if a property has an annual gross rental income of £15,000 and a value of £300,000, its gross rental yield would be 5%. This is calculated by dividing the annual rental income of £15,000 by the property’s value of £300,000 and multiplying by 100 to express the result as a percentage.
Gross rental yield is different from net rental yield, which takes into account additional expenses such as property taxes, insurance, and maintenance costs. Net rental yield is generally considered to be a more accurate measure of the return on investment from a rental property, as it reflects the actual income that a property owner can expect to receive after accounting for these costs.
Should you calculate the gross or net rental yield for investments?
Typically, net rental yield is considered more accurate because it takes into consideration the expenses of a property. Having said this, the gross rental yield can be calculated if the information about the expenses of the property is unknown.
Either way, it is up to the investor to make this decision and they should ensure they only compare net rental yields and gross rental yields to each other. Conflating the two statistics can lead to drawing incorrect conclusions and making poor decisions on what investment is actually more profitable.
Things you need to consider when calculating net rental yield
As discussed, there are a variety of expenses involved when looking at how to work out rental yield. Below are some of the variables that change the return on investment a property can produce.
Insurance premiums can impact how you work out rental yield by reducing the amount of income that a property owner can expect to receive from their rental property. This is because the cost of insurance premiums must be paid out of the property’s gross rental income, reducing the net rental income that is available to the property owner.
It is important for property owners to carefully consider the cost of insurance premiums when calculating their rental yield. Landlords may choose to go with more affordable insurance policies or they may choose to not take out insurances that aren’t mandatory. Read our article on insurance when buying a home to find out what is absolutely necessary.
Replacing damages in a property
Damages to a property are always a nuisance but they are likely to happen at some point. The more damage a property has, the bigger the impact in reducing a property’s rental yield. This is because the cost of repairing or replacing damaged items must be paid out of the property’s gross rental income and the smaller the income the smaller the yield.
Paying the ground rent of a property
Ground rents are paid by those who own a leasehold property. This means they own their home but they still have shared areas of the space they live in which they have to pay ground rent for that aren’t directly owned by them. This is an expense paid to the freeholder rather than an additional rent collected by the landlord.
As a result, when comprehending how to work out rental yield, the amount of profit being produced from the property is therefore less.
Calculating agent fees
Agent fees are not mandatory if you want to manage a property yourself and the extent of these fees can also be managed quite a bit. For example, you can choose whether to be a landlord with no agent at all, allow a letting agent to charge a flat fee or allow the letting agent to charge a commission of the rent for other additional services like property management.
Read our article on letting agent fees to see the options you have to choose from when deciding on these costs.
Void periods of rent
While it is something most landlords do not plan for and hope doesn’t happen for long periods of time, void periods of rent are quite likely and they could last for months if there is no new tenant that could be brought into a property.
You can reduce the impact of this by taking out rent guarantee insurance. However, this is an expense in itself if it is not already covered by the letting agent fees or included within the mortgage payments of a property. So whether rent guarantee insurance actually helps increase the figure after you have worked out how to calculate rental yields is dependent on the property in question.
Capital appreciation vs net rental yield
Capital appreciation relates to the increase in value of an asset over time. In the UK, this amount of appreciation must be calculated under the law in order to pay capital gains tax in the right way. This is completely different to rental yields because rental yields relate to the return on the capital invested in the property from rental income.
Capital appreciation can only be realised once the property has been sold whereas rental yields can be calculated based on the predicted rents of a property or throughout the duration where a landlord owns a property too.
The reason why these two figures are often talked about together despite them being completely different figures is that typically, the higher the rental yield, the lower the capital appreciation of an area. This is due to the relative rental demand in comparison to the buyer demand.
Depending on a landlord’s risk tolerance, preference and capital available, some may prefer to buy and hold and take advantage of capital appreciation in areas where buyer demand is high. Whereas others may choose to benefit from large rental yields in areas of the UK where rental demand is high. It is also possible to get a good balance between both.
Whatever method a landlord chooses to make money, they cannot get away from paying tax though. Capital appreciation is taxed based on capital gains tax and rental yields or rental income is taxed on the rate of corporation tax or personal income tax. Depending on how the property owner has the property set up under the law.
Capital gains tax is payable on the sale of a property but it also depends on the individual’s tax bracket. Whether you are in the basic rate threshold or the higher rate threshold, you will have an allowance of £12,300 which is completely tax-free. This is known as the “annual exemption”.
How to calculate capital gains tax in the UK
For a practical example of how capital gains tax may work in the UK in relation to rental yields, let’s take the example of an investor who is a basic rate taxpayer and is selling a residential property. If the property owner purchased the home for £100,000 and they tried to sell the home for £150,000 later on, the increase in value would be £50,000.
After taking away the annual exemption of capital gains tax of £12,300, the taxable gain on the property would be £37,700. The owner of the home would be required to pay £12,300 of the gain, or £2,214, and 28% on the remaining £25,400 of the gain, or £7,112. In total, the investor would be required to pay £9,326 in capital gains tax on the sale of the property.
For more information on capital gains tax and the rules and regulations governing the ownership and transfer of property in the UK, property owners can consult with a qualified legal advisor or visit the UK government’s website here.
How to calculate capital appreciation in the UK
To calculate the capital appreciation of a property in the UK, an investor must first determine the property’s current market value. This can be done by hiring a surveyor who will visit the property and give a valuation. The investor should then subtract the property’s original purchase price from its current market value to determine the amount of capital appreciation.
For example, if an investor purchases a property for £100,000 and its value increases to £150,000 over a period of time, the property has appreciated in value by £50,000.
The property’s capital appreciation can then be expressed as a percentage which is what most landlords and investors will use when communicating the value of their property. In this case, the property has appreciated in value by 50%.
It is important to note that capital appreciation is not guaranteed, and the value of a property can also decrease over time, resulting in a capital loss.
What is considered to be a good rental yield for a property?
To make things simple, the figure for what would be considered a good rental yield in the UK has to be looked at in relation to the area. For example, if you worked out rental yield for a property in the UK that is in Sheffield, a typical rental yield could be in the double digits and be 12% or 13%.
On the other hand, in areas of the UK that benefit from a large amount of capital appreciation, a good rental yield could be as low as 1%. For example in Kensington and Chelsea, central London. Landlords do not mind this lower figure because the value of the house goes up by a lot more than any other type of property because of the sheer amount of buyer demand in the area.
For more on how rental yields can differ throughout the UK, read our article on rental yields.
What is the typical rental yield for properties in the UK?
When looking at how to work out rental yield, you can expect the rental yield to settle around 3.63% in the UK on average. Compared to other cities in Europe, this rental yield is quite low due to the capital appreciation in the UK being a lot higher than other cities like Odense in Denmark which has a rental yield of 9%.
A lot of people aim to buy a house in the UK rather than rent, this is why it is common to have lower rental yields. Landlords also buy to make a capital gain on their investment too.
When wrapping things up, working out how to calculate rental yield is vital for those who want to make a smart investment. Not only do you have to consider this figure but you also have to know if it is worth it based on the predicted capital appreciation of the area too.
Do not be afraid to speak to legal professionals and ask for different opinions on how to work out rental yield before you get stuck in with making a big decision.