How to work out rental yields and ROI

When buying a property investment, knowing how to calculate rental yields and ROI can help you better analyse what a property can do for you financially. Below we’ll talk about gross and net yields and ROI, how to calculate them, and the importance of using these calculations to compare and assess property investments.

What are rental yields?

Rental yields are the return achieved on a property through rental income. It’s shown in a percentage and is typically calculated by taking the annual rental income and dividing it by the cost of the property. Rental yields provide a helpful way to compare property deals and can help you determine if a property is worth investing in.

It’s important to know the difference between gross yield and net yield and how to calculate each to fully understand what you can earn from a potential property investment. Both can be helpful in comparing and assessing properties.

Gross yield

Gross yield is calculated by taking the expected annual income from the property and dividing it by the purchase price. For example, if you purchase a property for £100,000 and would make £5,000 from rent annually, the gross yield is 5%.

annual rent income ÷ property price = gross yield %

The gross yield of a property investment offers a simple and quick way to compare properties to each other, especially if the costs related to the different properties are likely to be similar. The problem with only relying on gross yield is that it doesn’t take costs related to the property into account.

Net yield

Net yield calculates the yearly profit made from a property, so subtract property-related costs from the annual rental income, which is then divided by the purchase price. For example, if you purchase a property for £100,000 and make £5,000 from rent per year, while annual costs come to £1,000, this makes the annual profit £4,000, bringing the net yield to 4%.

annual rent income – costs = annual profit 

annual profit ÷ property price = net yield %

 

The costs to consider including are survey and solicitor fees, mortgage payments, refurbishments, insurance, managing agent fees, service charge, ground rent, and an allowance for repairs and void periods. The net yield provides a more accurate look at the yield you’re likely to take home each year.

What is ROI?

Return on Investment (ROI) is the annual profit of a property, which is calculated by subtracting costs and expenses from the income earned and then divided by the cash that’s been put into the property. It’s important to note that ROI is the same as Return on Capital Employed (ROCE) and Return on Cash (ROC).

If you bought a property using only cash, the net yield and ROI would be the same. However, if you bought a property with a mortgage, it will be different. Let’s look at an example. If you purchased a property for £100,000 with a mortgage for £75,000 (meaning you invested £25,000 of your own cash into the property) and earned an annual rent of £5,000 and expenses amounted to £2,000, you would see an ROI of 12%.

 

annual rent income – costs = annual profit

annual profit ÷ cash invested = ROI

In this example, the costs are higher because of the mortgage payments that need to be paid, making the profit lower. However, the ROI for the same investment is dramatically higher than the net yield, and this is because you’re putting less cash into the property. This means the return is slightly lower and your investment is much lower, making the ROI higher.

Costs to account for

Many property investors can’t agree on what costs to include in the calculations and how much you should allow for repairs and void periods. This is why you can get drastically different rental yields and ROIs depending on who’s calculating it.

What’s important is that you’re consistent with what you include in the costs in order to be able to accurately compare different property investments. This makes it all the more important that you calculate the potential rental yield and ROI of a property yourself.

Calculate rental yields and ROI

Check out the rental yield and ROI calculator below to help you assess property investments. This provides helpful insight into a property’s potential rental return, but it’s important to further assess the property itself and the property deal in order to make the most informed decision you can on a property investment.

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Posted on 1st August 2020

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