We Should Be Using Net Rental Yields

by Readers Question

4 months ago

We Should Be Using Net Rental Yields

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We Should Be Using Net Rental Yields

I have just responded to a Facebook post by axe the tenant tax, the post was about landlords losing confidence with rental profits. The article ended with the fact that rental yields are holding up at 6% I have done some calculations and would like those good at the maths to make comment or provide alternative figures. I believe that net rental profits are down to average of 2%

Too much talk about rental yields that are gross figures ie 6%, due to the recent government taxes we should now quote net yield for greater accurately. Paying tax has now become a cost of doing business due to the loss of interest as an expense.

I did a calculation based on an average property price of £190,000, average rent of £850 per month, average loan of 60%, average interest rate of 4.5%, average running costs which included full management or an employed team for the larger landlord like myself of which costs 30% of the rent if you do your figures right, I allocated 5% of the rent for capital improvements or to go into a sinking fund for long term improvements.

The figures I came out with were that 25% of the rent goes to the tax man, 25% pays the interest on loans, 5% to the sinking fund, 30% to running costs (which includes repairs, administration costs, management for all new rules and regulations), this left 15% after tax profit for the landlord.

Now at £850 per month that’s £10,200 per year and 15% of that = £1,530 after tax profit per year.

Now let’s forget the capital appreciation because no one includes that in working out the yields, capital employed and put into the purchase of the property is 40% of £190,000 = £76,000 and the return on investment for £1,530 after tax rent on our cash investment of £76,000 = 2.01%

So big difference from the quoted figures of 6%

Any one any comments.

Comments

Richard U

4 months ago

Well yes, you are right. But you are also wrong. We haven't helped ourselves as landlords in embracing yield as a metric. Which has typically been expressed as annual rent as a % of the property value. I think you are much better off using ROI - pretty much what you are demonstrating above and that unless this is a post-tax figure (post section 24) it's as unhelpful as yield has always been. With regards to models - the above demonstrates why BTL on the basis you have created above is a capital gain game now. Sadly there don't look like there will be any capital gains to be had in the short-mid-term. Personally the only way I can make a slightly better ROI, is by being better on those key figures: 30% deposit, £1200 rent, 20% maintenance/run costs (managed directly). Otherwise i'd be selling.

david porter

4 months ago

We have pretty houses, ie good visual impact, and our figures are gross, gross rents about 1000 pm each . Average purchase price circa 190k
We have been putting rents up slightly because of S24.
We had a void period in june but only 30 days but have a new tenant at more money. We are doing better than 2 % but not a lot better. This is not a short term investment. You have to be hear for perpituity!

david porter

4 months ago

Should have mentioned several new tenants have come from council fllats.

Trevor Cooper

4 months ago

There seem to be many different ways to calculate a profit, and I am sure that different people do it in different ways. The key is to know your numbers inside out and be consistent in your calculations.

Adam Withford

4 months ago

Reply to the comment left by Richard U at 10/08/2017 - 09:17I agree with Richard. Your investment is the capital you put in (deposit, conveyancing etc), not the gross purchase price of a property, unless you are buying with cash of course.

Appalled Landlord

4 months ago

Hi

Since you ask, I’m afraid some of the percentages are wrong. Interest is not 25% of rents; at £427.50 a month it is just over 50%.

Adding management costs of 30% makes 80%. This leaves a pre-tax profit of 20%, so the tax figure cannot be 25%.

However, your figures of 15% of rents as after-tax profit, and 2% after-tax return on investment (ROI) are likely to be right - before Section 24.

I have used your figures to see what effect S 24 will have on the rates of ROI in a couple of scenarios.

If you had 20 of these properties and no other income, last year you would have paid tax of £5,740 at the basic rate on your profit of £40,200, and your net income would have been £34,460 a year - 16.9% of rents. This would have been a 2.3% ROI.

However, in 2020/21 you would pay higher rate tax and lose the personal allowance. The tax on your real profit of £40,200 would be £29,900, leaving you with a net income of £10,300 a year, an ROI of 0.68%!

The tax would be 14.7% of rents, on top of 50.3% interest and 30% management costs, leaving you with 5% of rents to live on.

If you had 40 of these properties and no other income, last year you would have paid tax of £20,860 at the higher rate on the profit of £80,400, and your net income would have been £59,540 a year . This is 15% of rents, rounded off, as in your article. It is an ROI, rounded, of 2%, again as in your article.

However, in 2020/21 your tax on a real profit of £80,400 will be £73,280, leaving you with a net income of £7,120 a year, an ROI of 0.23%!

The tax would be 18% of rents, on top of 50.3% interest and 30% management costs, leaving you with just 1.7% of rents to live on.

The effect of S 24 will be dramatic. You are right, it is the after-tax ROI that is important. And Richard U is right, after-tax means post Section 24. The latter will make the gross yield even more misleading than it already is.

Appalled Landlord

4 months ago

Reply to the comment left by david porter at 10/08/2017 - 09:56Hi David

A recent report by the Joseph Rowntree Foundation compared the PRS with social housing. It seems unusual for someone to leave subsidised council housing to move into the more expensive PRS. Do you know why your tenants did so?

Rob Crawford

4 months ago

Rental yield figures are used as a quick and easy means of providing a calculation to compare the attractiveness of individual properties of similar condition during a sales process - not much more! Actual attractiveness to an individual will be dependent on that individuals situation, planned depth of renovation, mortgage gearing, impact of S24 etc. So a net figure will vary and is only relevant to the owners own or potential portfolio if calculated in the same way.

Sam Caine

4 months ago

I have a treasury background and hence prefer to look at cashflows rather than metrics that both vary and have no direct impact on me. Hence I look at the net rental revenues compared to the costs of purchase and maintenance to get my percentages. Hence I would agree with your returns of approx 2%. However, I wouldn't be disappointed - if you had invested in shares your return may have been 5% of £76,000. But after 25 years of the tenant paying off your mortgage you see the benefit as the property is worth at least double the amount of the shares, plus any capital gain differential.

In case this helps you, if I look at a property that I have held for 15 to 20 years, I get between 5% to 8% pa plus capital appreciation.

In my opinion, the question is do you want the inflexibility, time delay and legal challenges of property as opposed to other asset classes.

Sam

Mark Alexander

4 months ago

Reply to the comment left by Sam Caine at 10/08/2017 - 14:54Hello Sam

Interesting that you have a Treasury background, I'd like to know more about that.

You are comparing asset classes as if they are both investments. That's a bit like comparing apples and eggs to me because property is a business which requires ongoing management. It certainly isn't a passive investment. To argue it is would be like trying to argue that a car rental business is a passive investment, albeit cars rarely appreciate in value, that I will grant you. However, would you invest into a car rental business on gross rental yield alone?

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