The Fundamentals of Property Investment – Part 1
Should You Focus On Yield As A Property Investor?
When working with estate agents and valuers anywhere across the country they will quote a yield calculation. Gross yield definitely has its uses to assertion how hard an asset is working for you overall (especially where large corporations and funds are investing) but for professional property investors it is not the most important calculation.
• YIELD = (ANNUAL GROSS RENT / PURCHASE PRICE) x 100
Example: You buy an apartment for £100,000 and you rent it out for £7,200 per annum (£600 per calendar month) this would mean that you receive a 7.2% yield.
There are a number of issues with this calculation, firstly GROSS RENT includes expenses and those expenses vary greatly, to produce a true analysis, we need to look at profit after expenses. Secondly, PURCHASE PRICE fails to include purchase costs, stamp duty and refurb costs and also forgets the fact that we can leverage bricks and mortar investments, if you are buying all of your properties cash without leveraging then yield can be used as a quick calculation to see how hard the investment will work for you but as the first issue is with gross and net rent it still isn’t reliable and you will still need to go into further detail.
As a professional investor, we need to know RETURN ON INVESTMENT (ROI) which is tailored to you so only you can calculate this.
• ROI = (ANNUAL PROFIT / CASH INVESTED) x 100
ANNUAL PROFIT – gross rent less expenses, as you are not limited to renting your property out as a BTL, where standard expenses will be Mortgage, Insurance, Management, Service Charge & Ground Rent, Voids & Maintenance your expenses will vary. With strategies such as HMO (House in Multiple Occupation) and SA (serviced accommodation) your outgoings will be much higher as you will be paying the utility bills and extras such as internet, cleaning, gardening. In addition these properties are furnished so you need to consider repairs and replacements. This results in your percentage profit from gross rent being much lower than with a standard BTL strategy.
LEVERAGING (one of they key reasons property is a leader in the investment world) this tool allows you to spread your capital and purchase multiple properties benefitting from the capital appreciation of a larger portfolio! The lending will effect both your expenses calculation and your capital invested so both top and bottom of the ROI calculation.
CASH INVESTED – this will include all purchase costs, DEPOSIT (if leveraging), stamp duty, finance & legal cost, refurbishment, furnishing costs etc. which again can vary depending on what loan to value mortgage you take out and how much works are required to make the property suitable for your chosen strategy.
Example: purchasing the apartment at £100,000 with a £7,200 gross rent
Purchase & finance set up costs: £4,000
Stamp Duty: £3,000
CAPITAL INVESTMENT: £40,000
Rent: £600 pcm
Mortgage: £187.50 (based on 3% rate, interest only product)
Ground rent: £40
Service charge: £80
PROFIT £80.50 / £966
BEWARE – there are a lot of estate agents quoting the term ROI but they are doing so incorrectly – they are giving you the yield – if anyone quotes you ROI make sure to ask how they are calculating it.
To summerise yield is a good quick calculation best used for non-inclusive, unfurnished rental strategies. You should always work out ROI before spending time on the due diligence process. Investors set their own minimum ROI and CASHFLOW (profit from rent) based on their strategy, their own plan and goals – there is no right or wrong. So, if you haven’t already done so, start thinking about what you want from your investments and set your thresholds.
Click here to read our 3rd blog – ‘Assessing an Investment Opportunity’