What is yield in property?
How does yield in property work and what is yield in property. Imagine you are considering two investment properties – which is the most financially viable?
Property 1 will earn you £833.33 a month for a £200,000 investment.
Property 2 will earn you £1000.00 a month for a £250,000 investment.
The obvious choice is Property 2 , as you’ll receive more income for a slightly bigger investment. But actually, property 1 is the more attractive investment option.
This is what yield tells us. (Note: We’ll give you the maths behind the above example further on!)
Yield is an essential measure of the potential success of an investment property. Many investors still buy what they think are good investments based solely on the property “being bricks and mortar”. But really your initial purchasing decisions should be based first and foremost around the property’s yield.
Where is yield used?
Yield can be used as a forecast to help you decide whether to invest in a property. It gives you a better overall ‘picture’ of a property’s income potential – compared to, say, looking at expected capital growth.
It tends to be used by those involved in buying/selling commercial properties who want to get a truer value. Those situations might include:
- landlords contemplating a buy-to-let property
- buyers looking to invest in commercial property, such as a shop, warehouse or office block
- estate agents and property investment advisers projecting forward to assist their clients in decision making
- professional property valuers (e.g. surveyors). Find out more about what Royal Institute of Chartered Surveyors (RICS) surveyors do from their website.
Why do investors like yield?
Yield allows you to compare apples and pears. So, when two houses don’t look exactly the same, by using yield, you can see what the cash/profit-generating ability of each is. (This is as long as the costs associated with each property are similar).
The difference in their size, location and, capital values, can be smoothed out by looking at their yield.
How do I calculate yield?
There is gross yield and net yield.
Gross yield is a very rough measure that enables you to quickly calculate whether a property is a good bet.
Divide the annual income from a property by its price to find out its yield. So: (income / price) x 100.
Example – if a property costs £200,000 and it generates £10,000 pa in rental income, then its gross yield would be 5%.
Annual running and other costs aren’t included, so the final percentage figure may be slightly misleading. But gross yield is a good initial indicator of whether a property is worth perusing.
Net yield provides a more meaningful percentage, as it includes annual running costs such as repairs and maintenance.
Substitute the income figure above by a profit figure, generated by taking your annual costs off the annual income. The revised formula is: (income – costs) / price x 100.
Using the above example and where your annual running costs were £4,000, the net yield would be 3%.
Costs could include mortgage interest payments, stamp duty, void periods, managing agents’ fees etc.
Using yield to compare properties
So, going back to our first example and using the gross yield calculations, you can see why property 1 is the option that provides the higher yield:
Property 1 – will earn you £833.33 a month for a £200,000 investment.
Income: £10,000 pa / Investment: £200,000 x 100 = 5% yield
Property 2 – will earn you £1000.00 a month for a £250,000 investment.
Income £12,000 pa / Investment: £250,000 x 100 = 4.8% yield
Why agents use yield not ROI?
Return on Investment (ROI) is the annual profit (so, income minus costs) generated by an asset, divided by the amount of your personal investment.
The ROI is a very useful measure, but it can only be taken so far by agents. They only know how much a house could perform at – not how much cash/investment you can put into a deal. So they will use yield as an indicator. If you can negotiate the asking price of the property then the yield should improve. Agents will advertise on property listings like OIRO and OIEO
Why don’t mortgage lenders use yield?
Mortgage lenders operate on a number of factors including a valuation of your property purchase. They typically use a Loan-To-Value (LTV) calculation that means they won’t advance more than a specific percentage of the property’s market value. Check with your own mortgage broker for advice on what valuation method you can use against your properties and potential purchases.
Mortgage lenders look to the main market’s such as residential where they can and will lean towards bricks and mortar values of the property, than what it might yield you per annum. This is primarily because a lender will exit and sell any repossessed house as a residential property where they can. There are exceptions to this general principle, usually surrounding larger commercial property borrowing or commercial units which don’t sit well in the residential market.
Understanding yield means you have the figures to properly compare your investment options and make an informed decision. Of course, once you have spotted a property that seems to add up in terms of both gross and net yield, it’s also advisable to consider your projected ROI too, so you can get a total overview.
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