Capital gains can only be realised when a property is sold and so, although they may be a useful bonus when disposing of an investment property which no longer serves its main purpose, for most property investors the return on investment in a property is measured in terms of yield and therefore calculations on the potential ROI of a property depend on the ability to calculate yield accurately.
The calculation for gross yield is very simple. It’s (Annual Rent / Property Value) * 100
For example, if you receive £10K in rent on a property valued at £100K then the calculation is (10,000/100,000)*100=10 so your gross yield is 10%. With gross yield, there are only two factors to consider, rental value and property value. This means that it is very easy to calculate but not necessarily very helpful, since it completely ignores the fact that property investors typically have to spend some money insuring and maintaining the property.
Net yield may be a much more accurate indication of a property’s genuine investment value. The calculation is ((Annual Rent – Annual Operational Costs) / Property Value)*100. While this looks initially like there are only three factors to calculate, annual rent, property value and operational costs, in reality operational costs will probably consist of several different expenses, some of which may need to be adjusted to suit the annualised format.
All risks yield (Market Yield)
You only really need to understand all risks yield if you are planning to invest in commercial property. Basically ARY takes the standard calculations for yield and adjusts them to reflect the perceived risk of the property investment. While formal calculations of ARY are undertaken on solid, mathematical foundations, the basic rule of thumb is that lower-risk investments have lower ARY and vice versa.
It is vital to calculate yield using accurate figures
The above calculations should all be fairly simple to make if you are looking at yield on a property you already own or a property you are interested in buying from another investor. It can be more challenging to calculate estimated yields on properties which are not currently tenanted, especially if they require significant work to be done on them before they can be let. This is why property investors are well advised to do very careful research before undertaking any yield calculations.
Although this is not a formal term, it is a concept successful landlords tend to understand even if only unconsciously. You could think of it as the value of a good tenant. In other words, if you are careful about choosing your tenants and only let to people with a reliable stream of income and a good track record of paying their rent in full and on time and of using the property responsibly then you minimize the cost (and hassle) of running the property and therefore create what could be called invisible yield, which can be used as a selling point if you wish to dispose of the property. In other words, the time taken to pick a good tenant really is an investment in itself.
For more information on calculating return on investment or to browse a range of buy-to-let investment opportunities, please contact Hopwood House.