Calculating property rental yield

Ymcmatt

HappyMJ wrote: »

You don't count interest in the yield. The interest is variable and can change at any time. BTL loans are usually interest only (if you have sufficient deposit) and therefore run forever. You would not usually keep a BTL for more than 10 years. It's better to wait until the property has increased in price then sell realize the profit (hopefully paying no or very little capital gains tax) and reinvest in another one or two. If you waited 20 years your capital gains tax may wipe out a lot of the profit and the whole point is to not pay any tax at all.

Thanks alot bud. It seems to be a 50/50 with the different types of mortgage, repayments & intrest that is, some people say go for the repayments so you'll actually own the property.

Kynthia

Ymcmatt wrote: »

Thanks alot bud. It seems to be a 50/50 with the different types of mortgage, repayments & intrest that is, some people say go for the repayments so you'll actually own the property.

Are these people investors with BTL properties because owning your own home is very different to running a business? What is the most profitable and tax efficient method?

You need to take into account tax on the rental income and the allowable expenses that reduce it; what cash profit you will make each year when you take into account all expenses as opposed to just 'allowable' ones; how much your capital will make invested in the property as opposed to being invested in other products and what are the risk differences; how likely is it the property won't let or will decrease in value, how to reduce future CGT liability, etc.

princeofpounds

There are lots of different types of yield. You use different yields to answer different questions about a property. It's as important to understand what a yield means and how to interpret it, as it is to be able to calcutlate it.

For example, you might calculate a gross rental yield. That would be rent/price of the property (either purchase price or current estimated value). It's an easy figure to work out, but it's not very informative.

You might calculate a Net Operating Income yield. This is the most-used yield for corporate real estate investment, because it give you more comparability between properties. This is, in basic terms, (rent - operating costs)/price.

Up to you what you include in operating costs (things like voids for example are potential rather than definite costs), but it does not include debt service.

If you then want to deduct debt service, you are then reaching towards some kind of free cashflow yield for the investment. But it's not a particularly useful number as you are using a 'free cashflow to equity' numerator with a denominator that values the 'enterprise' (i.e. the property) rather than the equity of the business. (Google FCFE and FCFF if my terminology confuses you).

You can then go further and try to get some kind of Return on Equity yield, which would use the cashflow after debt costs divided by the equity in the property. This would tell you something about what your equity was earning (before revaluation gains/losses) but it's not really a comparable indicator as it's dominated not by the performance of the property but the financial structure you have placed on it.

Now, hopefully I have horribly confused you

In basic terms, the NOI yield is probably the most useful for simple BTL investment. Lazy people will use gross yields, but if you base your business plan on that it's not smart/

Once you have the yields, one of the MOST important things to understand is that even if NOI yield on the property is greater than the cost of debt, you will have hidden risks in your business plan if you assets (BTL rental stream) and liabilities (mortgage costs and your equity) are not perfectly matched. In particular, variable mortgages can totally change the equation at the stroke of a banker's pen.

Ymcmatt

Thank you all.

princeofpounds wrote: »

If you then want to deduct debt service, you are then reaching towards some kind of free cashflow yield for the investment. But it's not a particularly useful number as you are using a 'free cashflow to equity' numerator with a denominator that values the 'enterprise' (i.e. the property) rather than the equity of the business. (Google FCFE and FCFF if my terminology confuses you).

You can then go further and try to get some kind of Return on Equity yield, which would use the cashflow after debt costs divided by the equity in the property. This would tell you something about what your equity was earning (before revaluation gains/losses) but it's not really a comparable indicator as it's dominated not by the performance of the property but the financial structure you have placed on it.

Now, hopefully I have horribly confused you

I was ok up till this point lol however thank you for your help.

GDB2222

Ymcmatt wrote: »

Thank you all.



I was ok up till this point lol however thank you for your help.

Well, why did you ask the question in the first place? What did you have in mind?

Ymcmatt

GDB2222 wrote: »

Well, why did you ask the question in the first place? What did you have in mind?

I meant within the reply i got.

vectistim

princeofpounds wrote: »

For example, you might calculate a gross rental yield. That would be rent/price of the property (either purchase price or current estimated value). It's an easy figure to work out, but it's not very informative.

It can be a handy first order sense check - for me if the gross yield < 6% then it probably won't be worthwhile looking in any more depth at that particular property.

You need to do your homework as to what the achievable rent will be. Generally I find that if a place is for sale on the instructions of an LPA receiver the suggested rents are well above what I think I could achieve.

princeofpounds

It can be a handy first order sense check - for me if the gross yield < 6% then it probably won't be worthwhile looking in any more depth at that particular property.

That's true, I was perhaps overly dismissive. I think the point I had in my mind is that this is probably the figure people will try to sell you a BTL property on, but that the achieved returns are likely to be much lower than that.