Have you done your due diligence? This is a question that you will hear many times throughout your property investing education. It broadly refers to your own research, and the starting point when considering any property investment will be either Rental Yield or ROI. You may have come across Rental Yield and ROI in passing as they are commonly used terms. If you are confused or simply want to widen your knowledge, this article will be a worthy read.
Why bother with Rental Yield or ROI?
Time and time again stories emerge of people investing in property before educating themselves. Some people get lucky, some people get lumbered with a burden and others even make a loss. Maybe you have your own story to tell? So where can it all go so wrong?
Simple calculations such as Rental Yield and ROI give the investor an insight into how well a property will perform. They are essential for distinguishing a financial freedom investment from a millstone of negative equity. It is surprising then, just how many landlords and investors enter the property market without even considering the basics.
Perhaps this is the downfall of many. Following trends or taking uninformed advice will often lead to a troubled time ahead or simply an investment that could work much more efficiently if it was constructed differently. Ignorance is bliss until you reach a dead-end road of poor decisions and find yourself stuck with a significant financial issue. Due diligence is key to risk avoidance and if you want to know where to start, continue reading.
Rental Yield basics
Rental Yield is often favoured over ROI and is a metric you will likely find attached to the sale of private rental properties or commercial acquisitions. Rental Yield gives a very simple and quick estimate of how the returns earned from a property relate to the overall value of a property. Note that the focus is on the overall value of the property.
Rental Yield can be calculated as Gross Yield or Net Yield. Gross Yield is simply the total annual rental income divided by the purchase price of the property and multiplied by 100. For example:
Annual Rental Income £9000 ÷ Purchase Price £90,000 x 100 = 10%
Net Yield on the other hand, takes into consideration your expenses such as insurance, letting fees and mortgage costs for example. So to calculate Net Rental Yield simply take your total annual rental income, subtract all of your costs then divide it by the property purchase price and multiply by 100.
Annual Rental Income £9000 – Costs £5000 ÷ Purchase Price £90,000 x 100 = 4.4%
It can be seen how the difference between rental yield calculated on Gross Income and Net Income is significant. As Rental Yield focusses solely on the purchase price of the property, it does not consider the actual amount of investment money in the property, which is a considerable drawback. For example, whether we have £22,000 invested in our property purchased for £90,000 or if we have only £6,000 invested in that property will have a considerable impact on how ‘smart’ that investment is. This is when ROI can help.
ROI stands for Return On Investment and as its name suggests gives a simple indication of how hard your money is working. ROI also rather succinctly demonstrates the length of time it will take to retrieve all of your money back out of the investment. This is obviously important because the sooner you can extract your money the sooner you can invest it in your next project.
Similar to calculating Net Rental Yield, we start by calculating the annual profit from the property, as a reminder this is the annual rental income minus the total costs such as mortgage payments, maintenance, insurance etc. The annual profit is then divided by the amount of money left in the property then multiplied by 100. The amount of money left in the property will be expenses such as refurbishment costs, sourcing fees and legal costs. As an example:
Annual Rental Income £9000 – Costs £5000 ÷ Refurbishment Costs £15,000 x 100 = 26.6%
If we then take our ROI of 26.6% and multiply it into 100 we get 3.7.
100 ÷ 26.6 = 3.7
Based on the annual profit from the property it will take 3.7 years for us to earn all of the invested money back out. Once all of the money has been reclaimed from the property the Return on Investment will be infinite.
Which is better?
The more useful question, is when to use Rental Yield and when to use ROI? They are both useful tools but for different situations. Rental Yield is quick and easy, giving you a gauge of a property’s rental income against the overall property value. ROI on the other hand, will indicate how well your investment is working for you, but it will require further calculations such as mortgage payments, refurbishment costs and buying costs for example.
Rental Yield therefore may appear easier ‘in-the-field’, however with practice it will become easy to calculate ROI. Experienced investors will even be able to run rough numbers in their heads based on similar deals from the past. Whether you favour Rental Yield or ROI, the big takeaway is to always run the calculations on every property investment you are considering.
Some people can feel overwhelmed by numbers. If that is you, there is nothing to fear. Through our Advanced Training Programmes we go through these types of calculations, slowly and in detail, to build confidence and understanding. In addition we have a supportive private Facebook community, that is always there to give advice and help if you feel lost in a world of percentages. Most importantly, do not fall into the trap of ignorance. Due diligence will be your responsibility and yours alone, which is why we are here to educate and show the way with logical steps of progression.