Now if you have looked into property investing before or attended a networking event, you’ll probably have heard of these terms before.
These are the percentages which we use to breakdown whether a deal is worth investing into or not, as well as being able to compare deals on an equal metric.
Starting off with Gross Yield, the calculation for this is –
Gross Yield = Annual Rental Income/Purchased Price * 100%
Great… but what does that mean.
You’ve just bought a 3 bedroom Buy-to-let house that you purchased for £100,000. Just doing as a single-let to keep the figures simple, we rent out the house at £600 per month.
So, our Gross Yield on that investment would be (600 *12)/100000 = 7.2%
Now that on its own wouldn’t really tell us much, but we then use this figure as a comparable, having a base line yield that must be reached before doing any more research into or using as a quick method of checking the potential of a particular area.
Now what the benefit of Gross Yield is, is that it can be used as a really quick calculation to judge the potential of a deal or an area. However, on its own should not be used as the decision maker to invest in the deal.
Carrying on from Gross Yield, the change in calculation is –
Net Yield = (Annual Rental Income – Annual Expenses)/Purchased Price * 100%
Or to put it another way,
Net Yield = Annual Profit/Purchased Price * 100%
The reason this is better than Gross Yield is because without knowing the expenses of the property, you don’t know whether the property is going to running with positive cashflow. What this means is you don’t know whether there is profit going into your pocket, or a loss which is taking money out.
Going back to our previous example where the annual rental was £600 per month. If the expenses per month were £700, then every month you would be losing money on that property. Using only the gross yield formula, you would not be aware of this. However, using the net yield formula,
Net Yield = ((£600*12) – (£700*12))/100,000 * 100%
= (£7,200 - £8,400)/100,000 * 100%
= (-£1,200)/100,000 *100%
This negative figure would immediately tell you that the property would be losing you money.
Although this is not always perfect as you would have to find an estimate of monthly expenses for the property, and so normally you would only have an approximate yield to work off for a deal. With research into the areas, expenses and experience, you can be pretty accurate. This produces the more informative figure but does take a higher time investment to find all the particulars.
This is one of the benefits of Gross Yield over Net Yield, whereby you can analyse more houses in the same space of time as Gross Yield requires less information to calculate.
Although houses filtered by Gross Yield should then be analysed for Net Yield in my opinion to check that the house is profitable.
ROI – Return on Investment (or ROCE – Return on capital employed)
Finally, ROI. Personally, I believe the best metric in seeing whether a property is worth investing in, and the one I always calculate and present to investors.
ROI = Money Invested/Annual Profit * 100%
ROI = Capital Employed/Annual Profit * 100%
First of all, ‘Money Invested’ and ‘Capital Employed’ are the same thing just different wordings for you to understand if you come across either version.
Capital employed is how much money will be invested into the project. Consisting of the deposit, legal fees, refurbishment, stamp duty and potential other fees depending on the project.
The annual profit as we saw earlier is the annual rent minus the annual expenses.
Coming to our example again, we’re going to change the figures, so we have a profitable example.
So, keeping the £100,000 purchase price, we have £800 monthly rent but now our monthly expenses are going to be £400. (As a test work out the gross and net yield of this new example and post in the comments or email to me for practice).
For ROI we also need further information to calculate, this being what deposit we paid, what legal fees we paid and any other costs.
For ease we’re going to assume that we bought the buy-to-let in good condition and didn’t require any refurbishment costs, and with a standard LTV (Loan-to-value) mortgage of a buy-to-let being 75% we had to pay a £25,000 deposit and say £4,000 of legal fees.
So, the calculation would be as follows
Capital Employed = £25,000 + £4,000
Annual Profit = (£800*12) - (£400 *12)
= £9,600 - £4,800
ROI = £4,800/£29,000 *100%
How many banks in your area will give you an interest rate of 16.55% on your money.
The reason I prefer ROI is the direct link between the money you invest, to the return you can get out. That £30,000 sitting in the bank depreciating could be earning 16.55%. This is also only an example, using various strategies finding properties with ROI with 20,25,30% plus is possible and achievable.
In summary, these are the three yields normally mentioned when looking into the return from a property, and you should now know what is being said when these are mentioned as incentives to a deal. My preference is towards ROI as the best representation of what I can provide an investor, and so is what I focus on, but in the property market Gross and Net yield figures will be mentioned and so is best to know what they are.
Thank you for reading.