How to calculate gross and net rental yields

While there are many ways to compare and contrast different properties, one of the simplest involves the use of gross and net rental yields.

Once these figures have been calculated, it is extremely easy to compare and contrast different property prices, rental income and their comparative value for money.

Even though capital gains on property investments tend to be the main focus for many people, cash flow is essential and gross and net rental yields are a useful indicator of value for money.

Calculating gross rental yield

The gross rental yield of a property is fairly straightforward although there are some issues to consider. If we take this example:

Purchase price: £100,000

Annual rent: £7,000

Gross rental yield: 7%

There is also an argument for including one-off purchase costs such as stamp duty (where applicable), legal fees, etc. If we assume additional purchase fees of £4000 the figures change slightly:

Purchase price: £104,000

Annual rent: £7,000

Gross rental yield: 6.73%

In theory, both of the above calculations are correct but perhaps the inclusion of one-off purchase costs gives a better picture?

Calculating net rental yield

The net rental yield takes into account annual running costs for the property owner. If the property is let to tenants this may include maintenance, council tax, ground rent, insurance and other traditional property costs. In reality the vast majority of running costs would be included as part of the lease, with the tenant liable for payment. However, in order to demonstrate how to calculate net rental yield we will assume there are additional costs of £1000 a year payable by the landlord.

Purchase price: £100,000

Annual rent: £7,000

Annual costs: (£1,000)

Net annual income: £6,000

Net rental yield: 6.00% (if we add in one-off purchase costs the yield falls to 5.77%)

Compare and contrast net rental yields

It goes without saying that as a rental income increases (traditionally year-on-year) the net rental yield, based on the original purchase price, will also rise. However, there is also another way in which you can use net rental yields to compare and contrast the value of your property against others in the neighbourhood or other parts of the country. This is very important for those who are looking to build long-term rental income.

We will exaggerate the figures a little to prove a point when looking to compare and contrast net yields. Using the above example as the basis, let us assume that rent rises by £300 a year, annual costs by £20 each year and after five years the property is valued at £150,000.

Current market value: £150,000

Annual rent: £8,500 (£7,000 + five annual increases of £300)

Annual costs: (£1,100) (£1,000 + five annual increases of £20)

Net annual income: £7,400

Net rental yield: 4.93%

We can see that while net rental income has increased, the net yield has fallen from 6% down to 4.93% simply because the value of the property has appreciated at a faster rate than rental income.

Using the base purchase cost the net rental yield is actually increasing but in real comparative terms it is falling.

On this basis, this could prompt long-term buy to let investors to bank their capital gain on this particular investment and reinvest, if possible, into a property offering a higher net rental yield.

Calculating the net rental yield using the actual market value of the property, as opposed to the purchase cost, will allow you to compare and contrast different regions of the country indicating perceived levels of value.

Conclusion

Calculating the gross and net rental yields is vital when looking to invest in any property as part of a buy to let strategy.

It is also important to maintain a watchful eye on relative value for money with regards to the rental yields going forward, based on actual property market value as opposed to purchase cost.

Where cash flow and rental income is important these figures can be very useful in prompting a switch from capital growth assets to those with a higher rental income.