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Home » Good Rental Yield

What Is A Good Yield On Rental Property?

November 29, 2020 by David Leave a Comment

Good Rental Yield On Property

At the time of this posts publication I’ve got nine different properties in my investment portfolio. There are four standard buy to lets, a student HMO (house of multiple occupation) and four properties rented as serviced accommodation.

All have different yields, designed to maximise ROI (return on investment), but they were all purchased with a 10% yield target.

So that’s the answer right? 10%.

Unfortunately it’s not quite that simple, it vastly depends on how you fund your deals, and to show you why, I’m going to run through the detailed numbers on two of my deals.

If you’re planning to skim read this post then fine, no hard feelings, but please take note and fully understand the how to judge a good rental yield section. Your financial future is potentially on the line here.

*All data is done on the assumption of interest only mortgages over a 25 year term.

Deal One: Two Bed Ground Floor Flat (Newcastle)

This property is a two bedroom ground floor flat a 5 minute walk to the metro line which connects you to Newcastle city centre. It’s my second ever deal and it was bought for £39,000 but needed a complete back to bricks refurb including damp works in numerous locations, a new water supply, full rewire and new central heating system – once completed we were into the deal for £64,000 total.

Unencumbered Yield (ROI)

Money Invested£64,000
Rent P/M£550
Management Fee£55
Cash Flow P/M£495
Cash Flow P/A£5,940
Yields (ROI)9.28%

Financed Yield (Interest Only Mortgage)

Money Invested£64,000
Deposit (75% LTV)£16,000
Interest Rate4%
Rent P/M£550
Management Fee£55
Mortgage P/M£160
Cash Flow P/M£335
Cash Flow P/A£4,020
Yield (ROI)25.91%

The numbers clearly show that unencumbered the property yields at 9.28% however when you refinance with a buy to let interest only mortgage at 75% LTV (loan to value – meaning there’s a 25% deposit put down) it yields 25.91%.

Learning point: a key difference to note here is the annual cash flow difference of £1,920 (£5,940 vs £4,020). Without a mortgage the property cash flows more per month however with a mortgage you get most of your cash out of the deal which can be reinvested.

If you pulled your money out and used the full £64,000 across four properties of the exact same type with 75% LTV mortgages the amount of money invested would be the same but the cash flow would be £16,080 p/a as opposed to £5,940. Your money goes further when leveraged.

The difference in the two yields shows that a good yield on a rental property really does depend on if the property is unencumbered or financed. You should be aiming way higher than 10% if you’re planning to buy with a mortgage.

Deal Two: Two Bed Top Floor Flat (Yorkshire)

The second deal we’re going to look at is a two bedroom top floor flat in a popular Yorkshire tourist town. It has a balcony with fantastic rooftop views, it’s own parking space and is in a town centre location. It was bought new before the development was completed for £195,000. Decorating, furnishing and stamp duty meant we were into the deal for £211,000.

Unencumbered Yield (ROI)

Money Invested£211,000
Avg. Nightly Rate£145
Occupancy70%
Rent P/M£3,087
Management Fee£370
Other Costs£1,270
Cash Flow P/M£1,447
Cash Flor P/A£17,362
Yield (ROI)8.23%

Financed Yield (Interest Only Mortgage)

Money Invested£211,000
Deposit (75% LTV)£52,750
Interest Rate4%
Avg. Nightly Rate£145
Occupancy70%
Rent P/M£3,087
Management Fee£370
Other Costs£1,270
Mortgage P/M£528
Cash Flow P/M£919
Cash Flow P/Y£11,032
Yield (ROI)20.91%

On this investment we’re forecasting an 8.23% yield with no finance in place and a 20.90% yield with a 75% LTV mortgage at a rate of 4%.

Again there’s a significant difference between the two yield numbers. I’m sure you can see that a good rental yield massively depends on the circumstances of the purchase.

Learning point: on paper deal two doesn’t look anywhere near as good as deal one right? Well… deal two allows a lot more capital to be deployed in one go equalling higher cash flow numbers for less effort (in monetary value not ROI). The property is also in a desirable location, has already proven to have been purchased at below market value (you’ll have to take my word on that) and has a much higher chance of capital appreciation than deal one.

How Do You Judge A Good Rental Yield?

In short if you can get 10% on your deal unencumbered then I think you can consider that an excellent yield. There aren’t many products on the market investors can buy into that return 10% in the current climate and offer the security that property does.

Return On Investment

A medium risk equities portfolio would be expected to do 4-6%.

If you’re financing your deals then 10% is not going to be a good enough yield.

When you have finance in place it’s imperative you protect yourself against a potential rise in interest rates. If there isn’t enough margin in your deal then you risk not covering your mortgage payments with your rental income.

This is what rising interest rates would do to my first deal if it were financed with a 75% LTV interest only mortgage.

Property value: £64,000
Deposit: £16,000 (75% LTV)
Net monthly: £495

Mortgage cost 4%: £160 (profit £335)
Mortgage cost 7.5%: £300 (profit £195)
Mortgage cost 10%: £400 (profit £95)
Mortgage cost: 12.5%: £500 (loss £5)
Mortgage cost 15%: £600 (loss £105)

As you can see if interest rates go sky high then the deal starts to lose money. Remember this deal has a 25.13% yield at a 4% interest rate. If it was only yielding 10% once financed the numbers would look a whole lot different and it would be a much riskier prospect.

*Rental income was reduced to £327 p/m to reflect 10% yield once financed.

Property value: £64,000
Deposit: £16,000
Net monthly: £294

Mortgage cost 4%: £160 (profit £134)
Mortgage cost 7.5%: £300 (loss £6)
Mortgage cost 10%: £400 (loss £106)
Mortgage cost: 12.5%: £505 (loss £211)
Mortgage cost 15%: £600 (loss £306)

If you’re still following the numbers then it’s clear to see that a 10% yield when financed is a much riskier proposition than a 25.13% yield (almost suicidal in-fact). You could still have single digit interest rates and be losing money every month. In fact interest rates wouldn’t need to rise much at all and you’d be losing money on your deal.

Settling on a final number for a good rental yield when you have a mortgage in place depends on your appetite for risk but personally I wouldn’t want to be looking at any deals where I couldn’t absorb at least a 10% interest rate on my mortgage and still break even. That means you’d need a target yield of at least 15% (rent equivalent £400 p/m) with a financed deal in my scenario above.

I can’t put enough emphasis on stress testing your deals, if you’re financing them, against higher interest rates to make sure you won’t end up losing money if the economic climate changes against you. It’s irresponsible and quite frankly bad business if you don’t know your worst case scenario in all deals you do and that applies to any and all investments you make, not just property.

When Should You Deviate From Your Target Yield?

Target Yield

For me a good property investment yield is 10% unencumbered. If I can get close to that number, as per my deals above, then the financed deal aligns with my risk profile against rising interest rates.

I will however deviate from my strategy under certain circumstances and these are definitely things you too might want to consider.

1) When Opportunity Cost Is Higher

If you’ve got an excess of investable capital sat in the bank, effectively losing money against inflation, then even if your deal isn’t perfect it can still make sense to do it.

You can always restructure your portfolio at a later date and replace under performing assets. An underperforming but still profitable asset is often better than no asset at all.

If I was all into my Newcastle two bed deal for £70,000 instead of £64,000 with a 75% LTV mortgage my yield percentage would be down to 14.95% but I’d still be cash flowing £2,616 per annum. Over a 25 year term that’s £65,400.

The opportunity cost of not doing the deal could be potentially quite significant and inflation would be eroding my initial funds on top of the lost investment revenue.

Still make sure you do your risk tolerance calculations when factoring in opportunity cost to make sure you’re comfortable with the downside.

2) Potential For Capital Appreciation

On paper Deal One in Newcastle looks better than Deal Two in Yorkshire. Percentage wise the numbers are definitively better.

However my flat in Newcastle has way less potential for capital appreciation (the rise in the properties market price over time) than my Yorkshire property. It has very little scarcity value and is not considered to be in one of the more popular city locations. The Yorkshire flat is in a popular area where property of its type is hard to come by. It will no doubt go up in value before the Newcastle deal.

I don’t give a huge amount of weight to capital appreciation, as it’s invariably hard to predict, focussing on cash flow and my worst case scenario when deciding on a good rental yield. However I will sacrifice an amount of yield if I feel good about a locations potential for rising house prices.

3) Non Financial Upsides

There are many upsides that can come with owning property outside pure financial gain.

Holidaying in the property yourself, being able to keep a property that has sentimental value and running your own business from part of the property are just some example of non financial upsides worth considering.

These are only quantifiable on a personal level but don’t discount their true value. Sometimes property can yield more than just financial gain, and depending on the circumstances, that gain might be more important than money.

Great investments can yield much more than just financial reward.

4) Time Investment Required

Turnaround time on a project is another factor to consider when doing yield calculations.

We’ve got a small student HMO in Durham City which was turned around in under 4 weeks start to finish. It was snapped up quickly by two university students soon after and was making money.

I’m not going to suggest you start accepting much lower yields because you can deploy your capital quickly but if a deal is just falling below where your ideal yield point might be then it’s definitely worth taking into consideration how quickly you can turn it from a liability into an asset.

Filed Under: Property

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