Understanding Rental Yield and Capital Growth
Rental yield is the term used to describe the return on a property investment from a rental perspective.
For example – if a property is let for £1000.00 per month and is occupied for the full 12 months; you will receive £12,000 per annum. If this sum is greater than the cost of owning, maintaining and managing the property, you will make profit that will be subject to income tax.
When an investor compares rental properties, they will calculate the rental yields and see which is most lucrative. To do this, they will divide the annual rent by the value of the property and then multiply the result by 100 to get a percentage return on investment.
In this example, the costs of managing the property have been ignored, as these will differ depending on size of mortgage, the condition of the property and if a letting agent is being used. If the property in the above example cost £250,000 to buy, the following calculation would be used to determine the rental yield, which in this example is 4.8% :
12,000 ÷ 250,000 = 0.048
0.048 x 100 = 4.8%
If the property were cheaper to buy but the rent was the same, the return would be greater. Conversely if the property was more expensive to buy but the rent remained the same, the return on investment would be lower.
This is also known as capital appreciation and is the value by which the property goes up over time. The value of a property can also depreciate.
The percentage of the original purchase by which the property has increased will represent the return on the investment from a capital growth point of view.
To work out the capital growth you will need to compare the price you paid for the property with a current market appraisal.
A property bought 5 years ago for £200,000 is now worth £225,000, the following calculation would be used to show the return on investment, which in this case is 12.5% :
Current Price (£225,000) – Purchase Price (£200,000) = £25,000
Increase (£25,000) ÷ Purchase Price = 0.125
0.152 x 100 = 12.5%
Over the longer term, property prices tend to increase but in the short to mid-term they can go down (depreciation). So predicting what a property’s value will be in the future to calculate capital growth is speculation, you can only accurately calculate capital growth after the event.