Why understanding the rental yield calculation important

If you are considering buying a property to rent out, one of the most important factors to understand is rental yield. Rental yield is a simple but powerful way to measure how much income you are making from your investment. Whether you are new to property investing or already have a few buy-to-let properties, knowing how to work out rental yield can help you make better choices. It can also help you spot good deals and avoid costly mistakes.

What Is Rental Yield?

Rental yield is the return you get on a property in the form of rent. It is usually shown as a percentage. This makes it easy to compare rents on different properties. A higher yield means you are getting more income in relation to the value of the property.

There are two types of rental yield, gross rental yield and net rental yield. Gross yield is the simpler of the two. It does not take into account any of your running costs. Net yield is more detailed and subtracts costs such as maintenance and letting fees.

Understanding rental yield helps you see if a property is providing you with a good income. It can also help you work out if the investment is worth the risk and effort.

Why Rental Yield Matters in the Property Market

Property prices can vary a great deal from one area to another. For example, a flat in London may cost five times more than a similar flat in the North of England. But this does not always mean that it will provide you with a better income. Sometimes, cheaper properties provide higher rental yields.

Rental yield helps investors compare properties across different areas. It also helps you decide whether a buy-to-let is worth the cost. You may find a high-priced home in a nice area, but if the rent is low, the yield could be poor.

How to Calculate Gross Rental Yield

Gross rental yield is a simple way to measure the return from your rental income. It considers the annual rent in relation to the realistic estimated value of the property.

The calculation is simple. First, take the annual rental income. Then, divide it by the price you paid for the property if you bought it recently or its realistic estimated current market value. Finally, multiply the resulting value by 100 to get a percentage.

For example, say you bought your property recently for £200,000 and charge £1,000 per month in rent. The annual rent is £12,000 (£1,000 x 12). Divide £12,000 by £200,000. The resulting value is 0.06. Multiply this by 100. The gross rental yield is thus 6%.

The gross rental yield does not take into account any ongoing costs and gives you only a rough idea of the return based on rental income. Still, it is a good starting point.

How to Calculate Net Rental Yield

Net rental yield provides a better picture of profitability. It takes your running costs into account. These may include expenses such as maintenance, letting agent fees, insurance and mortgage interest, bearing in mind that mortgage interest-related tax relief is limited if a buy-to-let property is owned personally rather than through a company structure.

To work out the net yield, first take your annual rental income. Then subtract from this your annual running costs. What you are left with is your net income. Now, divide that net income by the value of the property. Then multiply the result by 100 to get the net yield as a percentage.

Using the same example as above, assume your annual rent is £12,000. Your annual costs are, say, £3,000. Subtract that figure from the rent and you are left with £9,000. Divide £9,000 by the property value of £200,000. You get 0.045. Multiply this by 100 and your net yield calculation is 4.5%. This is before taxes. If you own the property personally rather than through a company structure, your profitability will also depend on how much tax relief is available to you based on your tax return.  

Running Costs

When you own a buy-to-let property, there are many running costs you need to think about. These are the costs that come up while you own and manage the property. They can affect how much income you actually make. Here are the most common running costs that buy-to-let landlords must consider.

Mortgage interest

If you have a mortgage on the property, you will most likely be paying interest each month. Only the interest part of a mortgage counts as a running cost. The repayment of the loan itself is not included in the calculation of the net rental yield. However, bear in mind that mortgage interest-related tax relief is limited if a buy-to-let property is owned personally rather than through a company.

Letting agent fees

If you use a letting agent, they will charge a fee to manage the property. This is usually a percentage of the monthly rent. It can range from 8 percent to 15 percent. The fee often includes finding tenants, collecting rent and handling the tenant.

Maintenance and repairs

Every property needs upkeep. You may need to fix boilers, plumbing or broken windows. You may also need to repaint walls or replace carpets. These costs can vary, but many landlords set aside around 10 percent of their rent for maintenance each year.

Landlord insurance

You will need insurance that covers items such as damage, theft, fire and legal problems. Landlord insurance is typically more expensive than regular home insurance. However, it is essential for protecting your property.

Service charges and ground rent

If the property is a flat, you may have to pay service charges. These are essentially fees for maintaining shared areas such as hallways, lifts and gardens, a common buildings insurance policy, and a reserve fund. You may also have to pay ground rent to the freeholder.

Gas and electrical safety checks 

The law requires landlords to carry out gas safety checks every year. You also need an electrical inspection every five years. These checks cost money, but they are required to keep tenants safe.

Energy Performance Certificate (EPC)

Before you rent out a property, you must have an EPC. This shows how energy-efficient the home is. You must renew it every 10 years or earlier if you improve the home.

Council tax during void periods

If your property is empty between tenancies, you may have to pay the council tax yourself. Some councils give discounts, especially on unfurnished property, but this is not always the case.

Utility bills during void periods

Like council tax, you will have to pay gas, electricity and water bills when the property is empty. These can add up, especially if it takes time to find new tenants.

Furniture and fittings

If you offer a furnished property, you may need to replace items such as beds, sofas or kitchen appliances from time to time. Even unfurnished homes may need things like blinds, light fittings and appliances installed and maintained.

Licensing fees

Some councils require landlords to have a licence to rent out the property. This is more likely to be the case in areas with high numbers of rented homes. The fee varies depending on the location. Rented properties which are classified as houses in multiple occupation invariably require licensing and this has its associated costs.

Legal and accounting costs

You may need help from a solicitor for tenancy agreements or evictions. You may also pay for an accountant to help with your tax return. These are extra costs you will need to take into account.

Void periods

A void period is when your property is empty and not earning rent. During this time, you still pay your mortgage and other costs. It is smart to plan for at least some void periods over time.

Tenant referencing and admin costs

Landlords typically pay for background checks, credit reports and paperwork when taking on a new tenant. These may be relatively small expenses, but still add to the overall running costs.

Wear and tear

Over time, things wear out. Carpets, curtains, taps and light switches may need replacing, for example. Even if you do regular maintenance, wear and tear is a natural part of owning a rental property.

Garden and exterior upkeep

If your property has a garden, you may need to keep it tidy between tenants. Some landlords also cover gutter cleaning or roof repairs.

Marketing costs

You may need to advertise your property on rental websites or in local papers. If you use a letting agent, this may be included in their fee. But if you manage it yourself, you might pay extra for listings.

Understanding and planning for running costs is key to being a successful landlord. When you calculate your net rental yield, all of these costs should be taken into account. This will give you a clearer view of your real profit and help you avoid any surprises. On top of this, also consider the tax relief you may get and the tax you will need to pay at your marginal rate.

Mortgage Strategy

Understanding that the mortgage principal is not part of the rental yield calculation can help you choose the right type of mortgage for you. Many landlords take out interest-only mortgages for this reason. With interest-only loans, you only pay the interest each month. This keeps your running costs lower and makes your rental income more predictable. The loan itself is repaid when you sell the property or through an alternative long-term investment plan.

If you have a repayment mortgage, your monthly costs will be higher. But you are slowly owning more of the property, which helps build your long-term wealth. This is an alternative strategy, but when you calculate yield, you still only count the interest part as a cost.

How Rental Yield Affects Your Investment Strategy

Knowing the rental yield helps you determine your strategy. A high yield may mean strong income. A low yield may mean long-term capital growth instead.

Some areas provide high yields. Others provide high property value growth. You need to decide what you want from your investment.

If you want income, look for high-yield areas. If you want to build long-term wealth, a lower yield may be fine if the property will grow significantly in value.

Rental yields also affect your mortgage. Lenders often require a certain yield for buy-to-let loans. It helps make sure the rent will cover your mortgage payments. This is called the interest coverage ratio.

Conclusion

Rental yield is one of the most important things to understand if you want to invest in property. It helps you measure your return, compare properties and plan your finances. The gross yield provides a quick overview, while the net yield provides a fuller picture. On top of this, factor in restricted tax relief and tax at your marginal tax rate.

By taking the time to work out the rental yield before you buy, you can avoid poor investments and make smarter decisions. Knowing your yield is a key part of building a strong and profitable property portfolio.

FAQs

Q. What is a good rental yield?

A. A good rental yield is usually around 5% - 8%. Some areas provide higher yields but may have lower property value growth.

Q. Can rental yield go down over time?

A. Yes. If costs go up or rent goes down or rent does not grow in line with property price appreciation, your yields can fall. It is worth calculating these figures at least annually.

Q. Does rental yield include mortgage repayments?

A. Only the interest part is included in the net yield calculation.

Q. Is high rental yield always better?

A. Not always. Some high-yield areas may have more risk or lower property value growth.