Landlords know that there are two ways to make money through buy to let. Firstly, through any increase in the value of the property you buy and, secondly, via the rent you receive from tenants.
Capital growth on your property investment is, in most cases, only a long-term consideration. Most landlords buy houses or flats with the intention of holding on to them for many years, often due to the high costs associated with buying and selling property, such as legal fees and stamp duty costs.
As a result, one of the key short- and medium-term aspects of any buy-to-let opportunity is the rental yield that you can expect. Rental yield is the annual sum you can reasonably expect to receive in rent expressed as a proportion of the property’s market value.
Take, for example, a flat that is on the market for £180,000. If the current typical rental rate for this kind of home in this particular area is £900 a month, the total annual rental income would be £10,800 (assuming that the property had tenants for the full 12 months). This would give a rental yield of 6% (£10,800 divided by £180,000 is 0.06).
So before you add to your property portfolio, it’s a good idea to research the areas you’re interested in to find out what the typical property prices are as well as expected rent levels.
Local estate agents will be able to help you out with both figures, but it is also a good idea to carry out your own investigations into whether there might be any difficulties in finding tenants or in collecting rent, for example.
Using rental yields to make comparisons
The rental yield calculation is particularly useful for comparing how different properties are likely to perform. If a flat in one area has a realistic expected rental yield of 8% while an alternative on the other side of town is set to return 6%, you’re probably better off with the former – provided that you can afford to buy it and there are no differences in terms of how likely you are to find tenants.
But a straightforward yield figure is less useful when it comes to direct comparisons with other types of investment, such as stocks and shares. This is because buy to let often incurs a number of other one-off and ongoing charges, all of which should be taken into consideration when you’re working out whether or not to become a landlord.
For example, as well as the purchase price, you will face other initial costs, such as legal fees and stamp duty, not to mention any initial renovations you might need to make.
In terms of ongoing costs, as a landlord you will have to foot the bill for any maintenance as well as potential emergency expenses such as replacing a broken boiler. You may also have to pay letting agent fees when acquiring new tenants and there may be void periods to deal with, when the property is empty.
In many cases, though, buy-to-let investors are happy if their rental income covers these expenses – as well as the cost of borrowing on a mortgage*, if necessary – with perhaps a little extra income to spare every month, given that they will also hope to receive the long-term benefit of house price growth.
What is a good rental yield – and where can I get it?
As a rule of thumb, between 6% and 8% is considered to be a reasonable level of rental yield, but different parts of the country can deliver significantly higher or lower returns.
It is worth bearing in mind that yields can be lower in areas where the expected house price growth is highest, such as in London and the South East of England. This is because the potential for capital gains in the region pushes sale prices up, while rent levels are less affected.
Research published by the website TotallyMoney recently identified parts of Nottingham as having the highest yield levels in the country: in the NG1 postcode, average monthly rents of over £1,500 and typical purchase prices of around £150,000 means rental yields have been roughly 12% in 2018/19. This is thanks in no small part to the large local student population.
Yields in parts of Liverpool have approached 10% this year, while rates are also high in parts of Leeds and Newcastle upon Tyne – again, due mainly to the universities based there. In Scotland, Aberdeen has seen the highest yields this year of just under 7% in the AB11 postcode, while similar rates have been recorded in Cardiff’s CF10 area.
* Your home or property may be repossessed if you do not keep up repayments on your mortgage.