Recently we have had some demand to provide a basic guide to investment property and for those not in the know the following is a run through of what you should be aware of.
Maybe this is less pressing now for the small landlord due to the recent changes in the tax laws which impact small landlord’s tax planning but we thought we would set out a simple guide to calculate potential returns on property investment. As we are not financial advisors we suggest you also seek financial planning if you do want to investigate buying an investment property. What we are doing here is setting out in simple terms what you need to be aware of.
There are two main factors: –
1. The income i.e. rent
2. The capital appreciation resulting from the potential rise in a property’s price.
An investors total returns are the sum of both.
Calculating the Rental Yield and your Return on Investment
It is also important to calculate the annual rental yield as it will be an indication of the level of the return on your investment (“ROI”). This is not the rental amount at all. Knowing the yield as it is like knowing what the Annual Percentage Rate (APR) is for a savings account – you wouldn’t put your money in a savings account without knowing the APR so it is just as important to work out the rental yield. This is calculated by measuring the annual rent as a percentage of the underlying capital value of the buy-to-let investment. Therefore, if a property was valued at £100,000, and generates an annual rent of £6500 the gross rental yield would be 6.5%. This gross rental yield is a useful starting point in calculating your potential returns and helps give a landlord a quick and easy way in which to measure it against alternative property investments.
As we all know any landlord will tell you that, unfortunately, they don’t get to keep all the rent therefore the gross rental yield can be a bit of an exaggeration. The more accurate figure of the true cash return from the rental property is given by its net rental yield.
What returns mean
- Firstly, the rent. The net rental yield takes away the associated costs of generating the rental income. This might include any management charges, such as: letting agent fees, ground rent, service charges, repair costs and insurance charges. Other outlays may also come into play such as the mortgage (important to note that this is the interest only portion – which is deducted and may have further personal tax implications), decoration, gardening, and cleaning.
- Secondly, the capital gain. Although this will not normally form part of the landlords yield calculations on a day-to-day basis, over the long term can be an important element in the overall return. Typically, we know most landlords will hold their residential investment property for approximately 15-20 years according to Property Hawk and the ongoing surveys from the Association of Residential Letting Agents (ARLA). Over this type of period capital returns can be very important.
Setting up costs
Setting up costs include the initial costs involved in the purchase of the investment property such as the legal fees and stamp duty. Other capital costs might be any development/ refurbishment costs required. Finally, there is the cost of exiting the investment, i.e. selling the property. All these need to be factored into the overall calculation of a property investors returns
You also need to be aware that rent and other costs are likely to change over the investment period which will also need to be factored into the calculation of a landlord’s property investment returns. Rents can go down as well as up and void periods will also influence the ROI.