Calculating Yield

So how does a professional investor know that a property purchase is going to put money in their pocket? It’s called yield. Yield is defined as:

Let’s look at this in more detail. Yield really has only two key variables:

So to calculate yield you simply divide what you get out by what you put in and express it as a percentage. In mathematical terms:

1. What You Get Out Of The Property

Can you guess what you get from a property? Well I’ll help you – RENT! This is the only thing you can be assured of getting from a property with any real certainty. We’re not facing an undersupply of housing in the UK so it is safe to assume that you can expect a steady stream of cash, in the form of rent, as a direct result of owning a property.

Capital growth you can never be sure of. So NEVER factor it in to your calculations as its impossible to calculate! Professional property investors do invest for capital growth, that’s for sure, but there is no point factoring it in to your calculations as it can only ever be a predicted figure. Incorporating predictions introduces errors in to the calculations and I hate errors!

So the output for a professional investor is:

What you get out	Term	Definition
Annual rent – annual interest cost – expenses – tax	Annual rent	This is the amount of money you can expect to receive from renting out your property. Any other money received from the tenant such as electricity or gas bills is excluded as these receipts should just be covering the cost of the bills anyway.
		You assume a full 12 month rent without void. Voids are factored in as an expense below.
	Annual interest cost	This is the amount of money you will expect to pay in interest costs as a result of making the property purchase. You do not include any of the repayment part of the cost as this is not a cost.
		To calculate the annual cost you simply multiply the amount you need to borrow to buy the property by the interest rate being offered by the lender.
	Expenses	Typical expenses will be: Service charges and ground rent – This is applicable to leasehold flats in England and Wales. Under the terms of any long lease in England and Wales you have to pay ground rent (usually never more than £500 per year) and then a maintenance charge called a service charge to cover such things as gardening, repairs, insurance and management of the block.
		Look into these service charges as they vary widely. I have two similar flats in differing parts of the country where one charges £5 a month and the other charges £90 a month service charges. Not knowing the potential service charges can result in you making an unexpected loss after all other costs are deducted.
		Insurances – You may want all or some of the following insurances: Building, Contents, Rent Guarantee, Boiler, Plumbing and Electric Insurances. Whatever you decide to go for get quotes so you know what these insurances cost and you can factor them in. Some areas can be expensive to insure without you realising it. This could be due to historic flooding, common subsidence or regular burglaries.
		Letting agent fees – If you’re going to use the services of a letting agent get a breakdown of their fees. Ring them up and ask them to send you their fees list. Be very careful – do not go with the agent with the lowest headline rate. They have hidden costs such as marketing fees, tenancy renewal fees, inventory fees and whatever fees they can come up with! Try to get an idea of total costs for a year’s letting.
		Repairs – This has to be an estimate. I would tend to over estimate to ensure you don’t get caught out. Repairs do even out over time so try to factor in replacement of boilers, carpets, kitchens etc. and then annualise these total costs. £1,000 a year is a good figure to start off with ... unless you are thinking of letting out a 10 bedroomed mansion!
		Void periods and bad debts – Sometimes tenants do not pay the rent! You have to factor in tenants losing their job, deciding not to pay or absconding. If you’ve got insurance then this does not have to be factored in as it’s covered by the insurance.
		One thing insurances cannot cover you for is voids. So it is prudent to allow 1 to 2 months for remarketing and finding the right tenant for the property.
		Admin costs – This is usually a small amount but you have to factor in property licences, postage, paper, phone, computer and whatever costs you incur administering your portfolio.
		Other costs – This will be specific to the property. If you’re thinking of buying a riverside apartment in the city and renting it out to city professionals then your advertising costs may be that little bit higher than a studio flat up north!
		Now taking all of the above in to consideration you should come up with a figure. Hopefully this should be a positive figure as this will mean it’s potentially profitable. If it isn’t then stay away! Don’t try to tweak it to make it positive. You’ll find your initial figures will be closer to the true figure rather than your recalculated figures trying to make it work.
	Tax	Unless you live in a tax haven such as Jersey or Monaco you will have to pay tax. You need to be aware of the following when determining how much taxable profit you have made for the Inland Revenue to tax:
		Allowable expenditure – Some expenses are disallowable when it comes to tax. This means you cannot charge these expenses against your profit. The Inland Revenue have this rule about expenses: expenses have to be incurred necessarily, wholly and exclusively to the business for them to be fully deductible against your taxable profits.
		If expenses are not allowable then they may be partially allowable, such as mobile phone charges and the use of a private car.
		Allowable reliefs – You will be entitled to ‘non-cash’ expenses called reliefs where they allow a percentage of costs or income to be charged against your taxable profit. Reliefs include Wear and Tear Allowances and Capital Allowances.
		Basic or Higher rate tax payer – if you are a higher rate tax payer then you are taxed at 40% compared to 20% for a basic rate tax payer. This will mean a reduced net profit after tax figure. There is an argument that if you were a higher rate tax payer it could be more beneficial for you to invest in other tax friendly investments such as VCTs (Venture Capital Trusts). I do not agree with this as I think property investments are an essential part of anyone’s investment portfolio, but you have to consider all points.
		ISAs and pension investments can look attractive as they have so many tax benefits but the ISA allowances are very small and the pension benefits seem too far away where the benefits may never be realised. However, look at the yields of these investments and compare them to property. This should steer you towards property!

What you get out should only ever be assessed by what you put in. So let’s look at what you put in.