Rental Yield v Capital Gain
You may have already come across the terms Rental Yields and Capital Gain in the property industry, but what do these terms actually mean?
For existing and aspiring landlords alike, jargon can be confusing and even daunting at times when you’re unsure of the precise definitions which is why I decided to put some tid bits together explaining two of the most fundamental parts of the buy to let and lettings process - Rental Yields and Capital Gain.
In this blog we will delve into both terms in full detail and analyse whether we should prioritise one over the other for better returns.
What is Yeild?
Put simply, a “yield” is the annual return you can expect to generate on the rental property you own through the rental income you receive.
In order to calculate the rental yield, you need to be aware of;
- the sale price or current value of your property and
- the rent you expect to receive for the year
The potential rental yield on a property is then estimated by taking the annual rent of a property, dividing it by the home’s value, and then multiplying it by 100.
If, for example, your property was valued at £400,000 and your annual rental income was £15,000, your yield would work out as 3.75%.
Annual Rental Income
Alternatively, if your property had a value of, say, £250,000 and your annual rental income was £12,000, your yield would be 4.8%.
Annual Rental Income
The higher the yield, the better the return on investment or ROI.
As such, buy-to-let landlords typically use potential rental yields as a way of determining whether or not a property is a good investment. Yields tend to be better in more affordable areas where tenant demand is high and good rents can still be charged, as the initial investment outlay is lower and yields are therefore less squeezed.
According to recent research conducted by private banking company Kent Reliance in July 2019, the average national yield on a residential property has reached 4.5%, a two-year high, while the average yield in London sits at 4.1%, a four-year high for the capital.
'Around Greater Manchester, I am currently securing some ready to rent properties for hands off investors with yields of between 7% and 9%. Along with its affordable entry point on prices, it’s booming up north.
The above calculation is known as a gross yield. If you want to determine your net yield (the amount of money you actually take home), you’ll need to deduct all the expenses associated with letting a property from your annual rental figure before making the calculation. These expenses will include factors such as;
- Letting agent fees
- Landlord insurance
- Maintenance and repairs costs
What is Capital Gain?
Capital gain, sometimes known as capital appreciation or capital growth, is a key consideration factor for landlords. It is, in essence, a self-descriptive term when considering the following;
- How much will your home increase in capital value over time?
- How much could you get for your rental property if you ever come to sell in the future?
Capital gains have become a far bigger consideration for landlords in the last 20 years or so, as house prices have soared to record levels across the country.
Which one should you be prioritising?
On a basic level, landlords investing for the short-term should consider locations that could deliver high rental yields, while landlords with a long-term view may want to prioritise regions or cities with historical capital gains and steadily rising house prices.
It is possible, of course, for landlords to secure both strong rental yields and good capital gains over time – but there are no guarantees on this particular front. You should also be aware that rental yields and capital gains aren’t the only things to take into consideration when choosing where to invest. Just as important matters include (but are not limited to);
- Tenant demand
- How long rental properties stay on the market
- Working out the sort of rent you can realistically charge
For an example of a property focusing on yeild and capital gain click here.
You should also bear in mind what is likely to make a rental property more attractive before investing, some of which include;
- Easy access to town and city centres
- Local amenities
- Green space
- Good local schools
- Strong transport links
Rental yields are typically at their highest in commuter towns – particularly on the outskirts of major cities like Manchester – as homes here are;
- Generally more affordable
- Tenant demand is high
- Good opportunity to charge higher rents
- Chances of securing reliable, long-term tenants
If you have one eye on capital gains, you should consider up-and-coming areas which are likely to experience rapidly rising prices in the coming years or locations which have seen house prices rise steadily over a number of years, seemingly impervious to external factors.
You can never predict with 100% certainty what will happen to house prices moving forward, but you should typically be okay if you aim for areas where buyer demand is consistent or have been the beneficiary of recent or ongoing infrastructure projects (for example Crossrail 1 or HS2).
If you’re considering a property around Greater Manchester, I have a number of guides here on the towns surrounding the city which have their own;
- Tenant demographic
- Market flux in prices
If you are thinking of buying a property to rent out up north, please feel free to get in touch.