Mortgage company Together has produced a guide to calculating rental returns and setting rental prices. This is an extract from the original blog, which can be read in full on the Together website.
As a property investor – or potential investor – one of the first questions you may have asked yourself is ‘is it worth it?’ This quick guide can help you decide what rent to set, and how to calculate your return on investment.
Consider your costs
When thinking about setting your rent, take into account your outgoing costs relating to the property. These are likely to include any mortgage repayments, your lettings agent’s management fees, and regular maintenance, plus some less predictable one-offs.
If you’re in the process of buying a property, you may find it easier to obtain borrowing if the projected rent comfortably outweighs the cost of your mortgage repayments.
Check the local market
Of course, the going rate will play a large role in dictating what the rent is set at. A local lettings agent can give you a strong indication of what the property will likely let for on the open market.
A bird in the hand…
If you already have a reliable and trouble-free tenant, consider your options before conducting a rent review – even if the market has risen. Your tenant might decide to walk away if you increase the rent too sharply, and your new tenant may not be so low-maintenance.
Is the potential extra income worth the potential added hassle?
Consider making improvements
A few relatively inexpensive upgrades to your property could bump up the rental payments, although a lettings agent can confirm the local ceiling price – it may not be worth it. If it is, the outlay can often be recovered quickly, and provide long-term increased income.
Calculating your annual yield
‘Yield’ is simply another way of expressing the return on your investment. The larger the yield, the harder your investment is working for you.
Rental yields are easy to calculate. You simply take your annual rental income, and divide it by your initial outlay (i.e. the purchase price + any renovation/furnishing costs you incur before renting).
So, if you buy a buy-to-let flat for £78,000, then spend £11,000 getting it ready to rent, and rent it out at £600 per month:
- £78,000 + £11,000 = £89,000.
- £600 x 12 = £7,200.
- £7,200 / £89,000 = 0.0809.
Or, in other words, an 8.09% annual yield.
This calculation is based on the assumption that you’ve rented it out for a full 12 months. Remember to make deductions if you’re renting it out on a shorter-term basis, or it sits empty for a while between tenancies.
If you’ve not yet bought your property, you can calculate your potential yield by using a few ‘guesstimates’. Factor in your purchase price, your projected rental income, and imagine you’ve spent your full renovation budget (including contingencies) on preparing it for rent.
This will give you a ‘worst case scenario’ yield projection.
Calculating capital gains yields
A second kind of yield you’ll see is the increase in the value of the property.
To do this, you deduct your original outlay from the current market value, and divide the result by the number of years you’ve owned it.
You bought a house eight years ago for £77,000, and spent £14,000 doing it up. It’s now worth £135,000.
- £77,000 + £14,000 = £91,000.
- £135,000 – £91,000 = £44,000.
- £44,000 / 8 = £5,500.
This £5,500 figure is the annual capital gains yield.
Read the full article on the Together website.