Property investors are typically looking to achieve a capital gain and an income flow.
Income flows are sometimes measured and referred to as “yields”. That sounds complicated - right? People say, “I don’t have a degree in finance - I can’t understand that stuff”. Well it’s actually pretty straightforward as we explain below.
Yields are useful in that they provide a quick and efficient calculation to compare the expected financial performance of different properties, and also how a planned property investment would compare to what could be achieved from investing in other asset classes (such as shares).
In its simplest form, the yield is calculated as the annual gross rent received from a property divided by the cost of the property. For example, if a property costs £225,000 and provides £1,000 rent per month then the yield is £12,000/£225,000, which is 5.3%. This yield is called the “gross yield” and is typically the number referred to by lending banks, mortgage brokers and estate agents. As you can see, it’s not complicated mathematics, and it’s pretty easy to “bust the jargon”.
While the gross yield is a useful yardstick for comparing between properties, it is not ideal for comparing a property investment against other assets such as shares or stocks. This is because the gross yield fails to take into account the costs of running a property and the cost of letting it out.
To overcome this hurdle, many investors work with what is called a “net yield”. The net yield is calculated by deducting the following typical costs from the annual rental income;
- Maintenance costs
- Repair and replacement of fixtures
- Allowance for vacant periods between rentals
- Agents fees
- Ground rents for leasehold properties
Going back to our example above, if the associated costs of maintaining and renting the property are £3,000 per year then the net rent is £9,000 and the net yield is £9,000/225,000 or 4%.
In addition to gross and net yields, there are other alternative calculations that are used by investment professionals to take into account what are called “friction” costs (such as taxation) or, based on market value of the property as opposed to the original purchase costs. This is where it can start to get a little more complicated (but not necessarily add a great deal more information – its just looking at the same thing - differently!)
In summary, every investor tends to look at investment opportunities based on their individual circumstances and requirements. Our advice is to ignore the jargon, and simply pick a yield calculation that you are comfortable with (typically gross or net yield) and use it as part of your toolkit for making a good property investment decision.
Want to know more?
For more information on how Aspire can help you achieve your strategic objectives as a landlord please see our landlord guide. To help understand more of the "jargon" involved in buying and investing in property, then please see our buying and selling jargon buster blog.