Just like the most important statistic for a model may be the length of her legs, or the diameter of her waist, the most important measurement of a buy to let investment is its rental yield. This is the amount of money the property is capable of earning in rent each year, as a percentage of the property's purchase cost. But that is not what we are talking about here, calculating the total buy to let return on investment is a very different kettle of fish indeed.
Return on investment is a total for the length of an investment. Buy to let investments make money in the form of capital appreciation as well as rental income. On top of that we need to factor in rental increases over the period as well. Finally we need to factor in the costs; we need to measure the net rental income (after expenses) and add that to capital appreciation to work out the total return from a buy to let property investment. Buy to let rental payments are the main income flow, so we take the net income from this.
We have set up and exit costs, including things like stamp duties and capital gains taxes. We potentially have a mortgage to factor in, not to mention the fact that we need to predict house price growth in order to measure total return. Now you can see why most people only mention rental yield. Anyway, here are some examples that will hopefully teach you how to calculate the returns of buy to let investing. Thank fully many sites offering property investment advice offer a handy buy to let investment calculator.
Calculating the Returns for a 10 Year Buy to Let Investment
The easiest way to do it is to take the purchasing costs and make them part of the price. So if we are buying a £200,000 property and the stamp-duty, mortgage arrangement fees, solicitors fees and other costs added up to £5,000 then the sum we would measure appreciation and rental yield based from would be £205,000.
Each property in the UK has running costs, electricity, water, council taxes but most landlords will hand these off to the tenants. This leaves us with our landlord-specific costs:
The best way to do this is to sign up with a company like NPower Hometeam or an equivalent company for boiler maintenance. For this we will allocate £20 per month.
Letting Agency/Property Management:
Unless you plan to make managing your letting business a full time job then you will probably need to go down the route of property management. There are a range of options, some online letting agents charge a fixed monthly fee of as little as £45, but for full property management it is usually a percentage. The average is 10% but we were able to find one offering the service for 7%. We will however allocate 10% to property management.
You will need buildings, and contents insurance, landlord insurance is also a good idea, this covers you for things like major plumbing work and things that can go wrong in a rental property. We will allocate £500 per year to cover insurance.
This is any initial outlay on furnishings and appliances, as well as replacements. We will allocate £5000 for initial furnishings, and £2000 every five years to cover the cost of replacement.
So the costs will work as this:
Property purchase price including costs: £205,000
So we will measure the rental yield from £210,000 in year one, and £200,000 in subsequent years. Capital appreciation will be measured off £200k.
- Property Maintenance: £20
- Property Management: £0 - 10% commission on rentals achieved.
- Insurance: £41.66
- Furniture: £33.33 (£2000 every 5 years is £400 per year)
Total: £196.55 rounded to £197.
Rental Rate: £850 pcm
Net Rental Yield:
To work out net rental yield we take the rental rate minus costs, multiply it by 12, then divide by the purchase cost, and multiply by 100 to turn it into a percentage.
Rental yield: £653 * 12 / £210,000 * 100 = 3.73% rental yield
The current rate of inflation recommended to be added for investors is 4%, because we will be taking this off our average appreciation, we will add it to our rental income every year, and to the expenditure as a workable average as well.
Year One £850 - £197 = £653 * 12 = £7,836
Year Two £884 - £205 = £679 * 12 = £8,148
Year Three £919 - £213 = £706 * 12 = £8,472
Year Four £956 - £221 = £735 * 12 = £8,820
Year Five £994 - £230 = £764 * 12 = £9,168
Year Six £9,168 + 4% = £9535
Year Seven £9535 + 4% = £9916
Year Eight £9916 + 4% = £10,312
Year Nine £10,312 + 4% = £10,724
Year Ten £10,312 + 4% = £11,152
Total Net Rental Income (except management fee): £94,083
Total Net Rental Income (including 10% management fee): £84,674.70
Total Rental Income over Term: £84,674.70
According to the Halifax house prices in the UK have been rising at 10.3% per year for the last 40 years. So we will take 10% for a capital appreciation average over the term of our investment, and then take away 4% for inflation, leaving us with 6% average growth.
6% of £200,000 = £12,000
6% of £212,000 = £12,720
6% of £224,720 = £13,483
6% of £238,203 = £14,292
6% of £252,495 = £15,150
6% of £267,645 = £16,059
6% of £283,704 = £17,022
6% of £300,726 = £18,044
6% of £318,770 = £19,126
6% of £337,896 = £20,274
Total Capital Return: £158,170
Capital Appreciation £229,230 Plus Rental Income(minus management fee) £84,674.70= £313,904.70
Total Return Minus Purchase Price £322,373 - £200,000 = £113,904.70
Total Return as a Percentage = £113,904.70 / £200,000 * 100 = 56.95%.