We Should Be Using Net Rental Yields

We Should Be Using Net Rental Yields

8:36 AM, 10th August 2017, About 4 years ago 31

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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

by Richard U

15:57 PM, 10th August 2017, About 4 years ago

Reply to the comment left by Sam Caine at 10/08/2017 - 14:54Sam - I think you may be double-counting. Most landlords don't use a repayment mortgage, and it's only the interest element that can be treated as a cost. So you can't get a return and pay off your mortgage. You have to use the return to pay off your mortgage. So therefore the 'profit' comes from measly rental returns and unreliable (and in my opinion, unlikely at least in the short-term) capital gains. Think I'll take the 5% return, with a reduced workload and improved liquidity.

by david porter

17:10 PM, 10th August 2017, About 4 years ago

Reply to the comment left by Rob Crawford at 10/08/2017 - 14:141) Water ingress when the wind blew the wrong way
2)ELEVATOR used as a urinal
3)Graffitti 4) Parking a long way away
I have been told.

by Sam Caine

17:20 PM, 10th August 2017, About 4 years ago

Hi Mark,

Perhaps. What is the definition of an investment? It's probably different to each individual. Like you say, I view a car as a tool, but I know several people who consider them an investment and make good money from them. The taxman still takes his cut from the profits so I assume this is also an investment 🙂 And yes, you are right, I wouldn't invest in any business based on gross rental yield. I would look at actual cashflows as these are based on fact rather than supposition. In my experience, whether an investment is considered active or passive is based more on the individual investing than the asset invested in.

Hi Richard,

I wouldn't say double counting - I just choose to reinvest as I have a long term view on property as an investment and the ones that I choose. But yes, I do realise that the majority seem to prefer interest only mortgages. I believe for one to be satisfied with an investment, you have to be very clear about your expectations of that investment and then find an asset class that is the best match for you.

Sam

by Sam Caine

17:57 PM, 10th August 2017, About 4 years ago

Hi Richard,

I forgot to explain why I don't consider it double counting. Ha!

Say you have a share and you get a dividend on that share. Most people take the dividend and buy something. However, you can also reinvest. Conventionally, if you reinvest the dividend to buy further shares, your capital investment would increase. This is, I assume, why you mentioned double counting on the properties - that the rental cash inflows are used to pay off the mortgage debt. So, yes, technically, I would agree. However, for my personal investments, I would consider the flows from my bank account to be separate from the investment. So, for example, my investment is only the cash outflow caused to purchase and maintain the property. Cashflows created by the investment can be used for maintenance, debt repayment etc in order to generate a greater return afterwards. Just like, if I give my child a sum to invest and he/she generates an income from it, even though I have to include that on my tax return, I don't consider it mine but that of my child.

It's another way of looking at the same apple 🙂

Sam

by Mark Alexander

18:26 PM, 10th August 2017, About 4 years ago

Reply to the comment left by Sam Caine at 10/08/2017 - 17:20Hi Sam

Not wishing to put words into your mouth but; are you suggesting that a person who owns just one property and outsources the management of it is not running a business?

If so, I don't accept that logic.

It may be a small business but it remains a business nonetheless. The owner of the property may have outsourced some responsibility but remains personally accountable for around 180 separate pieces of legislation, some of which can result in prison sentences if they are not complied with. There may well be a contractiual responsibility passed to the property manager for many of these but the accountability never changes.

This is very different to investing into other asset classes such as shares or gold isn't it? An owner of shares in a company would never go to prison for the actions or inactions of that company unless he/she was an officer of that company.

by Appalled Landlord

20:11 PM, 10th August 2017, About 4 years ago

Reply to the comment left by david porter at 10/08/2017 - 17:10Thanks David

I have posted your reply on the JRF thread.
https://www.property118.com/poverty-evictions-forced-moves/comment-page-2/#comment-93493

by Sam Caine

8:34 AM, 11th August 2017, About 4 years ago

Hi Mark,

No, that wasn't what I meant at all. I agree that running a property business, whatever size, is complex and demanding. Indeed, I am surprised at how many people start BTL despite the challenges.

My intention here is to confirm to the original writer of the question that I agree with his/her criticism of using a market valuation to calculate a return. I also prefer to use factual numbers rather than estimations/valuations to calculate how well an investment is doing.

If you buy a bond for £100 on year 1 and it gives a coupon/dividend of £5 per year. The bond has a life of 10 years and is floated. At time X the market value is £80 and at time y the market value is £120. The bond guarantees to return £100 at the end of the 10 year life.

So the question is, do you value the bond at :

5/100 the dividend over the purchase price paid
5/80 the dividend over the market value at time x
5/120 the dividend over the market value at time y
5/100 the dividend over the guaranteed sales price

In my opinion, each valuation can be correct. I prefer to only use factual cashflows hence I would normally use 5/100 as there is 100% certainty that I will receive this. I would only use 5/80 or 5/120 if I have a contract to sell at that price.

Hence, for person who started the question of net rental yields, I would agree - I do not calculate net profits over current market value to estimate my return. In my opinion, using a market valuation incorporates too much uncertainty for me.

Yes, I agree that it is very different to holding shares/bonds/commodities. I would also agree that holding financial instruments is easier, more flexible and more liquid. And yet there is clearly a strong attraction for so many people - as evidenced by your website 🙂

Sam

by Mark Alexander

10:00 AM, 11th August 2017, About 4 years ago

Reply to the comment left by Sam Caine at 11/08/2017 - 08:34Hi Sam

Thank you for clearing that up.

As a matter of interest, when you said you have a "treasury background", were you referring to HM Treasury or something else?

by Sam Caine

12:01 PM, 11th August 2017, About 4 years ago

Hi Mark,

Corporate treasury, so that includes : business valuations, corporate restructurings in order to minimize tax etc. My definition of good fun!

Sam

by Mark Alexander

12:06 PM, 11th August 2017, About 4 years ago

Reply to the comment left by Sam Caine at 11/08/2017 - 12:01Mine too funnily enough 🙂

Who do you work for?


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