Calculate Buy-to-Let Net Yield

Net Yield gets closer to the actual profitability of the investment. This is the rent less the costs of managing the property including void losses, maintenance, letting, and all other operating costs, relative to the total cost of procurement:
Gross Rent | 14,400
Less voids & bad debts | -755
Less management | -1,000
Less maintenance | -2,000
Less repairs | -1,000
= Net Rent | 9,645

In our example the net rent is expected to be about £9,645, giving a net yield of 3.72% before taking tax into consideration. After tax that comes down to 3.39% for basic tax rate payers, or 3.06% for those paying at the higher 40% rate. There are no published tables of net yield on residential investments, although ARLA publish net yields that take account of void losses, and ignore the other costs.

Management and maintenance costs are examined later. In the example they come to 30% of the gross rent. According to a report by E C Harris in 2013 the average loss of gross to net income ranges typically from 33% to 35%, based on data from the Investment Property Databank. So the provision for these in the example used here might be a little optimistic.

ARLA also publish what they term ‘geared annual investment yields’ which they also show net of void losses, but without taking account of the running costs such as management and maintenance, or interest charges. These show the return on the property value net of the mortgage loan. Their figures are based on quarterly surveys of residential landlords and their agents which showed that in the fourth quarter of 2013 the average loan to value ratio was 41.4%. Consequently this gives much higher yields averaging 12.95%.

Gearing is an important concept to understand. A simple example will illustrate the way it works. Suppose someone buys a house for £100,000 with a £75,000 loan, and £25,000 of their own money invested. After a number of years the property doubles in value to £200,000, but the loan remains at £75,000. So even though the value of the asset rose by 100% their initial £25,000 deposit has now grown to £125,000, so it has risen by 500%. That is gearing. It is particularly relevant to an investment in housing, because such a high proportion is usually funded with a mortgage loan.

The way ARLA assess the geared yield has the advantage of being unambiguous. But it also exagerates the benefits, because it takes no account of the costs of borrowing and all the other operational costs. A more realistic way of assessing the geared yield would take all the operational costs and taxation into consideration. In our example property ARLA’s crude assessment of the geared yield would express the gross rent as a percentage of the cash invested to procure the property:

14,400 / 79,600 = 0.181 or 18.1%

Based on net rent it would be 9,645/79,600 = 12.12%, and after tax of £1,163 that would become 10.66%.

Although slightly better than gross yield, net yield is still only based on one year’s performance, and ignores longer term changes in operating costs. The absence of any consensus on how it should be calculated also undermines it as a useful measure of viability. For all its faults, gross yield is universally understood. Net yield is not.

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