Rental yield calculation - why not just use the deposit?

7sefton

Hi everyone.

Can someone please explain why BTL yields are calculated using the full property value, rather than just the deposit I’ve put down for the mortgage?

As I see it, I’m interested in the return I’m getting from my actual investment, rather than the notional value of the house.

Ie. If I have a BTL worth £200K and I’ve put down a 20% deposit (=£40K), surely any rent I’m taking in is a return on that £40K?

Eg. 

£10K rent / £40K deposit = 25% return

But orthodox gross yield calculation would be: £10K rent / £200K property value = 5% yield

I’m simply asking because when working out whether my £40 is better in BTL than other assets, I’m tempted to use ‘my’ yield calculation but I’m worried that I’m missing something obvious when everyone else seems to talk about the orthodox yield!

thanks. 

7sefton

Also, I guess another way I could look at it is the rental return on my equity in the property. In any case, I still don’t get why using the whole property value is an accurate way to assess my personal return. 

eddddy

They are 2 different calculations used for 2 different purposes.

If a £200k property delivers £10k pa in rent, you can say its gross yield is 5%
If a different £190k property delivers £8k pa in rent, you can say its gross yield is 4.2%

So it helps you to compare the 'attractiveness' of the 2 properties.

But as you say, your 'Return on Investment' calculation would be different. And you might use that calculation to compare the "attractiveness" of starting a BTL business, against investing in an investment fund.

payless

Yes.  Bulb. ROI would however be. 

Annual Rent less expenses .. such as interest. / initial investment 

Slithery

7sefton said:

Ie. If I have a BTL worth £200K and I’ve put down a 20% deposit (=£40K), surely any rent I’m taking in is a return on that £40K?

Eg. 

£10K rent / £40K deposit = 25% return

But orthodox gross yield calculation would be: £10K rent / £200K property value = 5% yield

That's not how it works.

You will have made two completely separate business transactions.

You have borrowed £160k from a bank at an agreed interest rate.

You have then added £40k of your money and spent £200k on a property. You own all of it - the bank just has a registered charge against it so you can't sell it without their agreement - they don't actually own any of it.

grumiofoundation

7sefton said:

Also, I guess another way I could look at it is the rental return on my equity in the property. In any case, I still don’t get why using the whole property value is an accurate way to assess my personal return. 

You can use whatever you want when to calculate your return. 

If you want to calculate a 200k property (made up of 40K deposit +160K Interest Only mortgage) as being only 'worth' 40k for your calculations then you can. It doesn't actually make a difference to  the rental return of the property. As said above they are 2 different calculations.

Thrugelmir

Using your method. What's the net rather than gross return. Will be a far more meaningfull figure. To use 25% is just kidding yourself with a case of confirmation bias. 

AdrianC

7sefton said:

Can someone please explain why BTL yields are calculated using the full property value, rather than just the deposit I’ve put down for the mortgage?

As I see it, I’m interested in the return I’m getting from my actual investment, rather than the notional value of the house.

Your actual investment IS the full purchase price, not just the equity.

You've spent the rest of the money to buy that house... it's just that it's money you had to borrow in order to spend. You still owe that money, and until you repay it, you're paying interest on it. You have a £200k asset and a £160k debt.

You have £40k of your own.
You could put £200k into a bank account by borrowing another £160k.
You could buy £200k of company shares by borrowing another £160k.
You could start a company with £200k capital by borrowing another £160k.
You're choosing to invest £200k into a single rental property by borrowing another £160k.

Jenni_D

And you need to pay off the mortgage (whether through capital reduction or interest-only) ... where's the money for that payment coming from if not the rental income?