If you are considering your first rental property or thinking about adding to your portfolio, this guide will explain how to calculate the rental yield. Doing this simple research will give you confidence that your purchase, whether it be with cash or a buy-to-let mortgage, is a sound investment and will not only bring in the income you want, but perform well against other investment classes, like shares.
A rental yield calculation is especially useful for those landlords investing in property to boost their retirement income. But it is also a key performance indicator for landlords managing a portfolio of properties with a focus on capital growth and regular income.
What is Rental Yield?
Rental yield is the percentage figure derived from dividing your annual rental income by the price you pay for the property, and then multiplying by 100 to give a percentage. The higher the rental yield percentage, the better; higher yield means the capital you invested in your property is working harder for you.
How to Calculate Rental Yield
Would you rather do it by hand? Here’s how to calculate rental yield in three steps without using a calculator.
1. Find your annual rent
Multiply the property’s monthly rent by 12 to get the annual gross rental income.
2. Divide your annual rent by the property value
Find the current market price for the property, the price you intend to offer, or the price you paid for it. Divide the annual rent from step one by the property value.
3. Convert to a percentage
Multiply the result of step two by 100 to produce a percentage. This is your annual gross yield from the property.
Rental yield calculation example
Let’s take a simple example. You have a two-up, two-down terrace rental that you purchased for £150,000. The monthly rent is £700.
- Multiply the monthly rental by 12, so £700 x 12 = £8,400
- Divide £8,400 by 150,000 = 0.056
- Multiply by 100 for the percentage result = 5.6%
How much could you be letting your property for? Use our Rent Calculator to find out!Calculate market rent
What is gross yield versus net yield?
Like all forms of profit and loss calculations, however, that is not the end of the story. The 5.6% rental yield in our example is the gross yield, giving the headline figure. If you were the landlord, in this case, you would know you don’t make a 5.6% profit each year as you have expenses to factor into your bottom line. When you take all these into account, you will end up with your net yield, which is a far more accurate determination of the profitability of your rental. In summary, net yield is gross yield minus your costs.
Suppose you are planning to buy a property with a buy-to-let mortgage, hoping to use it for future retirement income. In that case, your net yield will look different over time as you hopefully pay down and clear the mortgage, meaning you lower costs to deduct from your rental yield calculation each year.
Gross Yield = annual rent / property price * 100
Net Yield = (annual rent – annual costs) / property price * 100
Defining a good rental yield
A good rental yield is generally considered to be between 5-6%. Anything above that is excellent. With that being said, it does not make anything below that a bad investment; it rather depends on what your goals are.
For example, if you are 50 years old and your net yield is currently 3% because you are making interest and capital repayments on a buy-to-let-mortgage, you plan to see your net yield rise to 6.5% when you reach 65 and your mortgage is paid off. You should make your property investment based upon your short- and long-term goals.
The eagle-eyed among you will have noted how two things can significantly affect your gross yield – the purchase price and expected rental. You can influence both of these by seeking out a bargain and buying at a low price, or better still by widening the area you consider to purchase. Properties in some towns and cities are lower priced but still bring in good rental values.
Although the rental price and the sale price of residential properties are linked, there are always some areas where market rents are high relative to average sale prices. These are the areas that will be of most interest to people looking to invest in property and achieve a good yield on their residential property.
Rental Yield Formula for Buy-to-Let Properties
As we have seen, if you make mortgage payments on your investment property, your net yield will fall below your gross yield. But the mortgage is not the only expense you should factor in when calculating your net buy-to-let yield. But what other costs do you need to include in your percentage yield formula?
Costs for property investors to consider
You will know how much you paid for a property, but if you’re planning on making a new investment, then some research online will give you a reasonably accurate figure for the type of property you’re after. If you have an upper limit you’re willing to invest, you can use this at first while you assess rental income.
Seasoned investors will already know how much rental income they can expect. New investors, however, can again research the rental market in their local area. Use our rent calculator to find local market rents by postcode search. It uses UK-wide lettings data for a great assessment of the going rates.
Now you must be realistic about the expenses that come around time and again. Don’t be tempted to downgrade any of these expenses; it will only give you an unrealistic rental yield at the end.
Multiply your monthly buy-to-let mortgage payments by 12 to get your annual figure. This is your interest payments if you are on an interest-only deal, but will be your capital and interest repayments otherwise.
Tax on rental income
If you are letting a property you own as a private individual, you will have to pay income tax on your rental income.
All landlords must provide Gas Safety Certificates and heating servicing. Properties also now need an Electrical Installation Condition Report, to be renewed every five years, and a Portable Appliance testing report is best practice to fulfil your electrical safety duties. (Note that white goods like washing machines or fridge freezers count as portable.)
Tenant searches and renewals
Sadly, it is rare to find one excellent tenant who will remain in your property over the long term. You must, therefore, factor in the cost of searching for new tenants and renewing tenancy agreements. Estimate this to happen on average every two years. The cost will vary from thousands of pounds if you use a high street agent to less than £50 if you use an online letting agent.
While the tenant is responsible for general maintenance and upkeep, the landlord will need to order or perform repairs to the structure, exterior and roof. They must also replace furnishings that stop working due to wear and tear or age. Just how much you factor in here as an annual cost will depend on the age, size and condition of the property, as well as how many furnishings you provide.
Some landlords factor in 10% of annual rent on repairs and replacing furnishing; this can seem like a lot of money to count on losing, but the cost of replacing a washing machine alone can be several hundred pounds. It’s easy to see how these things can quickly add up.
Letting agent fees
Using a letting agent can take a lot of hassle out of finding, vetting and dealing with tenants – although an incompetent agent will simply multiple your problems!
If you do want to use an agent, be careful about how much you will be paying. Some agents charge a large percentage of your rent every month. For example, if you use Foxtons to find tenants and manage the property, you’ll pay 20.4% of your rent to them, plus £450 for a tenancy agreement. That’s going to have a huge impact on your yield.
What about capital growth’s effect on my investment?
If the market price of your property changes while you own it (which it almost certainly will) then the difference in price is your capital growth. While property prices can go down, they have overwhelmingly increased by many multiples in the last 50 years, increasing in value far above the rate of general inflation.
If you plan to sell your property after 10 years of renting it out, then the ‘disposal’ (i.e. sale) of that property from your portfolio should be factored into how you think about it as an investment.
For example, if you think that your property will have increased in value by £10,000 in that time, then you should factor this into your annual calculations, adding this value, minus any capital gains tax you must pay, to the income you forecast yourself to receive from the property’s net rental yield.
The problem here of course is that it is much harder to predict property value uplift than annual market rents. And although many institutional investors do regularly make eye-watering investments that count on property prices increasing to be viable, it can all go horribly wrong if the price increase you are relying on doesn’t occur.
In short, the best advice is not to count on your property price increasing, but to see it as an added bonus if it does.
Make Informed Decisions Using Rental Yield Calculations
Once you have gathered together all your costs and worked out your net yield for your new property investment, you can make a far better decision on how and where to invest.
This will give you the confidence to go ahead with a purchase if you consider the rental yield to be what you desire. But equally, it will provide you with the data you need to swerve a potential purchase and look elsewhere.
Using the rental yield calculator process, you will become adept at making tweaks to the purchase price, rental and expenses to see how it determines the result. Negotiating down the purchase price, buying a nearly-new property with little upkeep needed, buying in an area where rents are higher, re-negotiating your buy-to-let mortgage, perhaps also increasing your deposit, will all make a positive difference to your yield.
Remember, all profitable businesses budget in a similar manner, and make adjustments accordingly. Unless you are buying an investment property for fun – highly unlikely – you will want to run it along business lines. Only then will you work towards getting the return on investment that you hope for.