When you become a landlord it is important to consider what kind of income you can expect from your rental property, especially if you are relying on this income to pay the mortgage. Calculating your property yield will help you to work out whether the property you choose is a sound investment.
There are two ways to make money by owning property. The first is by capital growth, which generally occurs in the medium to long term as your property increases in value (this is not always guaranteed, although it has been true in the recent past). You will only benefit from capital growth when you sell or remortgage the property. The second is rental income, which is the amount of money you receive in rent from your tenants. This will hopefully increase over time as well.
Calculating Your Property Yield
To calculate your annual property yield, you take the property’s yearly rental income and you express it as a percentage of your investment in the property. For example, if you charge £1500 per month in rent for a property that you bought for £200,000, your yield would be as follows:
- £1500 x 12 = £18,000 per year rental income
- £18,000/ £200,000 x 100 = 9%
So your property yield would be 9% per year, which would be a healthy return on your investment.
Costs to Consider
But wait; while this figure is accurate, it does not take into account the costs you will be liable for on your rental property.
As a landlord you will need to budget for a range of expenses related to the upkeep of your rental home. These expenses will be subtracted from your rental income (and can be offset against tax).
First of all you will need to make sure that you have landlord’s building and contents insurance. The buildings insurance premiums should be about 2-3% of your rent and contents insurance (depending on the level of furnishing) should be another 1-4%. Insurance is helpful if you decide to furnish your property because you will be liable for the costs of repairing and replacing fixtures and fittings when they break or wear out. The initial costs of furniture, fixtures and fittings should be about 10% of your annual rental income, and you will need to ensure that any soft furnishings you provide comply with fire safety regulations. Also remember that you will need to redecorate every few years!
You will also have to pay maintenance costs on your property. The amount of maintenance that you will need to carry out depends on your property’s age, condition and size. It is worthwhile considering this when you buy, as constant maintenance problems can be a significant drain on rental income. As a landlord you are liable for all major repairs to your property and must fix any fault that affects the structure of the property, the exterior, as well as heating, hot water, electricity and plumbing. You will need to get all amenities regularly checked by qualified, accredited tradesman and will have to have all the relevant electrical and gas safety certificates.
If you are renting a property as a shared ‘Multiple Occupancy’ tenancy you may need a license from the local authority. There are special rules with this type of tenancy that limit the number of people occupying the property, and you may have to comply with extra fire and electrical safety standards. Whether you need a license depends on the size of the property and varies by council. Be aware that landlords are obliged to make ‘reasonable adjustments’ to accommodate a disabled person.
It is worth bearing in mind that your property may not be tenanted all year round, and as a guide you should budget for one vacant month per year, called ‘void periods.’
If you decide to employ a letting agent to manage your property you are likely to pay fees in the region of £500 per year for a range of services, depending on the size of your property. You should shop around for deals as many agents will offer discounts to new landlords, and independent agents may offer a personalised service.
Once you have factored in all your costs, you will have to pay your mortgage (if applicable). If you have done your research correctly, you should make a profit after all your costs are taken into consideration. If this is not the case, you can decide to rely on the capital growth of the property, accepting little or no yield in the short term in the hope that property value or rental rates will increase in the long run. Whether you are able to do this will depend on your financial situation.
The final thing to remember is that you are liable to pay income tax on any rental income your receive. You may offset mortgage payments, maintenance and other costs against tax. The amount of tax you will pay depends on any other sources of income you may have and is charged at 20% or 40% depending on total income. If you are unsure, consult a financial advisor.