Investing in buy-to-let property: rental yields



If you’re considering investing in buy-to-let property to help fund your retirement, there’s a lot to think about. Like most investments, the return earned on a residential property comes from two sources:

  • Capital appreciation/depreciation – this is the rise or fall in the market value of the property over time, net of one-off capital expenditure costs.  You can find out more about this in our article Investing in buy-to-let property: capital returns.

  • The annual yield –in the case of residential property, this is the rental income net of ongoing costs. This is what we’ll cover here.

Finding facts about rental yields

Historic data on rents received and rental yields is scarce. But, since 2006, the government’s Valuations Office Agency (VOA) has reported data on rental amounts via the Office for National Statistics.

The chart below uses rental amounts from the VOA.  The VOA compiles data for the whole of Great Britain, but we also want to show how this compares to house price data (You’ll find this in our article Investing in buy-to-let property: capital returns. This data is only available at national level, so to make comparison easier, the following chart uses data for England only. However, these comparisons are for illustration only and similar trends have been experienced in Scotland, Wales and Northern Ireland.

The graph shows the gross rental yield available on average English properties over the last 11 years from February 2006 to February 2017:


Source: Valuations Office Agency

This comparison provides a gross rental yield – the percentage annual return relative to the property purchase price. For example, if a property were purchased for £200,000 and the rental income was £10,000 a year, the gross rental yield would be 5%.

As you can see, if the average English residential property was purchased in August 2007, the gross rental yield would have been around 4.5%. If the property was purchased in April 2009, the gross rental yield would have been around 5.8%.

This shows that rental yield – the gross annual return you can expect on a buy-to-let property – fluctuates according to house prices, with higher yields available when house prices are lower. Just like any other investment, it makes good financial sense to buy when prices are low.

The net rental yield

The actual rent received is not the same as the amount of regular profit you will make. There are costs and risks involved in owning a buy-to-let, and these must be taken into account. When calculating the net yield, we need to deduct regular ongoing costs (but not one-off purchase and sale costs). The following are some of the costs and risks that should be considered:

  • Void periods and unpaid rent

These are periods where you don’t have a tenant and no one is paying rent. This can happen at any time, but most likely when you first acquire the property and when old tenants move out and new ones move in. Problem tenants may also remain in the property without paying rent. 

  • Maintenance & refurbishment  

All properties need to be maintained, from simple repairs to plumbing or electrics to expensive building work such as roof and chimney work. These costs need to be taken into account.

  • Letting agent management and finder fees

Letting agents levy charges for finding new tenants and for ongoing property management. Of course, many landlords do this themselves – and although this reduces cash expense, it comes at a cost of personal time.   

  • Mortgage interest

Mortgage interest is a cost for most buy-to-let landlords. And, although some tax relief is allowed (more on this later), interest payments need to be factored in.  

  • Cleaning costs

This is a greater issue for those who let on a short tenancy basis, such as holiday lets. However, these expenses will arise whenever there is a change of tenant. Again, many landlords will seek to minimise costs by doing the cleaning themselves.

  • Advertising fees

You’ll need to pay to advertise the property, each time it is re-let.

  • Legal fees

In order to evict a tenant, you will need to go to court, costing you both time and legal fees. 

  • Insurance

You will need to ensure that the buildings and contents are properly insured.

All of these costs can have a significant impact on the real yield you receive on a buy-to-let investment, so make sure you take these into account when calculating the real investment return.

In 2016, MSCI, a company which carries out financial analysis, reported that net rental yields from residential properties across the whole of the UK averaged 2.5% in 2015.    

 

Example

Assume you bought a flat for £200,000 and let it out for £900 a month, giving a total annual rent of £10,800 and a gross rental yield of 5.4%. Let’s also assume that you put down a 50% deposit and borrowed the remaining £100,000 at a fixed interest rate of 2% on an interest-only basis.

The following are examples of the potential costs:

·         Void periods – assume 1 month in every 12 – cost £900 in lost rent

·         Maintenance, refurbishment and decorating – £1,000 a year

·         Letting agent fees – 10% of gross rent or £1,080 a year

·         Mortgage interest – 2% on £100,000 loan – £2,000 a year

·         Cleaning costs – £200 a year

·         Insurance – £350 a year

·         Advertising costs – £200 a year

TOTAL COSTS – £5,730 

Deducting these costs from the gross rent of £10,800 leaves a net return of £5,070 a year or a net yield of around 2.5% a year.

Please bear in mind that this example is for illustrative purposes only, and actual costs may be lower or higher.

  

You might also be interested in…

> Investing in buy-to-let property: capital returns

> Retirement Planning: pension vs property

 

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