There are several ways of describing Return on Investment (ROI) from a rental property and serious landlords have a firm handle on the differences.
The most relevant definition you might consider is likely to be the one that satisfies your main reason for investing. You may be interested in the long-term sale prospects as an investment for your dependants for example. Conversely, the net monthly rental revenue might be an important part of your day-to-day income. It all depends on your motivation. Here’s a quick overview of the three main terms:
Gross Yield: This used to compare potential investment opportunities. It is the percentage of the purchase price that the annual rent represents. So, a £200,000 purchase with an expected rent of £1,000 a month (i.e., £12,000 pa) would be regarded as a 6% gross yield. But this is not the amount of “profit” you would be making because it does not consider the costs involved. It is more about the relationship between purchase price and rental value when making a relative buying decision.
Net Yield: This is the amount of “profit” your investment makes, after deduction of all associated costs, such as managing agent fees, maintenance, insurance, and mortgage interest. Using the above example, if the combined costs equated to say £5,000 pa, then the actual yield works out at 3.5%. The bulk of this is likely to be mortgage interest, so your net profit is closely linked to your “gearing”. Some people are happy to forego annual yield on the basis that as long as the rent covers their costs, then they get a “free” long term investment where Capital Appreciation is their profit.
When calculating Gross or Net Yields during future years of ownership we suggest you should consider the current rent against the current sale value of the property, not the price you paid for it.
Capital Appreciation: This is the amount a property has appreciated, either by improvements, market appreciation or both. Again, expressed as a percentage, investors should be careful to ensure that the uplift (hopefully) is annualised across the term of ownership. A property purchased in 2012 for £200,000 and sold ten years later for £300,000 may have enjoyed an “impressive” 50% growth, but annualised over ten years this equates to just 5% (although not bad compared to the FTSE100 index at only 2.4%pa). You may also wish to add in the accumulated Net Yield you have received over the years when calculating this return on investment.
This is a specialist field and as investment managers and letting agents we have a pretty good handle on these things. Why not ask us to help you decide on the relative merits of your next potential rental investment?