A common problem many first-time home buyers have is viewing too many properties and then feeling more confused about which are the best properties to buy. To overcome this issue, you need to understand ‘rental yield’.
Rental yield is a formula whereby the rental income is calculated as a percentage of the property value. In simpler terms, this means:
- My property rents for $600 per week so the annual rental income is $31,200 ($600 x 52 weeks)
- My property is valued at $350,000
- My rental yield is 8.9% ($31,500 / $350,000 x 100) Got it?
Now how do I apply the rental yield when house hunting?
I think too many people fall in love with a property because of its ‘cosmetic’ characteristics, such as the décor and furniture, landscaped gardens, newly installed kitchens and bathrooms, and so forth. The reality is, you need to look beyond this – think with your head before your heart – and that’s when the power of rental yield comes in.
Now, let’s say you have viewed three properties in the same town with the following details:
One bedroom apartment which rents for £300 per week and is on sale for £180,000
The rental yield for property 1 is 8.7% (£300 rent x 52 weeks / £180,000 x 100)
Two bedroom apartment which rents for £350 per week and is on sale for £220,000
The rental yield for property 2 is 8.3% (£350 rent x 52 weeks / £220,000 x 100)
Two bedroom apartment which rents for £450 per week and is on sale for £280,000
The rental yield for property 3 is 8.4% (£450 rent x 52 weeks / £280,000 x 100)
Now some people might think that property 3 is the most valuable investment as it’s the most expensive apartment. However, for me, at the initial research stage, property 1 appears to be the better investment on paper because it has the highest rental yield of 8.7%.
This means that property 1 will bring you the most rental income in its current state. If possible, consider dividing the one bedroom (in property 1) into two separate bedrooms; thus increasing your rental income potential. Two bedroom apartments can often rent for more money than one bedroom apartments.
There are obviously other highly important factors which may also impact your purchasing decision, such as location, transportation links, town regeneration plans, building regulations, planning permission and so forth – all of which I will discuss individually in future blog posts.
But from an absolute starting point, and from the perspective of a property investor, I think rental yield should be the most important factor during your initial research stage because rental yield is a statistical fact that is objective. This means that you are not relying on your emotions or personal preferences to determine if a property is going to make you money.
Referring to rental yield can also save you time. By time, I mean you can filter down the number of properties you view by selecting the properties with the highest rental yield.
Here is my general rule for applying rental yield:
As a general rule, I do not view any properties with a rental yield of less than 5%. However, what makes a good renal yield percentage is dependent on the area you live in. Experts will give you different rental yield averages but I say, just do the calculations on a few properties within your desired area to determine the average rental yield percentage.
Please note, though I own a few properties, I am not a legal, financial or professional property expert. I’ve written this post to share my personal experiences and would love to hear your opinions and views.
So, what are your thoughts on applying rental yield for your property search?
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