House prices are rising...Rents are rising...Yields are rising...good news as it is but: how can they all be rising when rents and house prices are part of the opposite sides of the yield equation? Well it’s all about the numbers…
So, in order to answer this we should look at the concept of yield a little bit more closely...
In this article yield is defined as the rental return divided by the current value of the property or:
Annual total rent / current property value (with the result expressed as a percentage)
This formula is more correctly known as 'Gross Yield' and a return of 6.3% is a reasonably good rate return for a single let property.
So, if house prices (current values) are up AND if rents are also up then for Gross Yield to also be up must mean that rents are growing faster than house prices, as it is all in the maths. Today, I do not intend to discuss how this is possible or whether it is reasonable, as that could take some time. My focus today is actually on using metrics or the numbers as our guide. So what other metrics can we use as our Key Performance Indicators (KPIs) as the accountants call them?
Here are some of mine (all expressed as a percentage, except cashflow):
Gross Yield - as described above, although some people use the purchase price instead of the current value – current value gives us a more current view however:
Gross Yield = annual total rent / current property value
Net Yield - the aim here is to understand what return you are actually making on your investment property after all the costs are taken into account. You may be shocked or disappointed with the results here, especially if your interest rate or maintenance costs are high but I would also look at my ROI calculation (see below) before taking any rash decisions and remember that over time this should improve anyway:
Net Yield = annual total rent less total annual costs (letting fees, mortgage interest, insurance & maintenance) / current property value
Yield on Debt - the aim here is to work out how much of a buffer you have between your rental income and your mortgage interest costs. I consider any discounted or fixed rate I am on now and also the lender's standard variable rate (SVR) to get an idea of how much 'headroom' I have. It is handy as it tells you by how much your interest rate needs to rise to wipe out your profit should your rent stay the same. I compare the result to my mortgage interest rate (discounted or SVR as mentioned) and can then decide on any action that needs to be taken such as re-mortgaging or looking to change the rent. Note that we could get clever with this formula and take our other costs off too but that overlaps with Net Yield to some extent so I personally don't:
Yield on debt = total annual rent / outstanding mortgage balance
Return on Investment - this means how much money am I getting back on my actual cash invested in acquiring the property and getting it ready to let (deposits, fees, refurbishment costs, etc.), excluding borrowed funds. This is an excellent way of working out how well my cash is working for me and I can use this to compare alternative investments if I wanted to (e.g. deposit account returns or ISA returns etc.). One of the beauties of property investing is that we can 'leverage' our cash funds up by using a mortgage to be able to buy a more expensive property, which we tend not to be able to do with other investments. This means that the returns are based on the higher purchase price whereas our actual investment is limited to only our own cash funds invested excluding borrowings. This last metric is one of the reasons why I am drawn to property investing. Note that, if you refinance after a refurbishment that you may be able to recover some of your initial cash investment and so your actual cash left in could also be reduced, making the calculation even better:
Return on Investment = annual total rent less total annual costs (letting fees, mortgage interest, insurance & maintenance) / total cash invested (deposit, fees, refurb costs, etc.)
Cashflow - this is not a percentage calculation as such; it is merely a calculation that tells me how much cash before maintenance and taxes my property is generating. I like a positive figure of course as this acts as a buffer against interest rate rises and maintenance costs. Note that over time the cashflow from a property should increase anyway as rental increases kick in over time and the mortgage debt remains fixed. The calculation is to add up all the fixed monthly costs of holding the property and deducting the result from the total monthly rent:
Monthly cashflow = monthly total rent less monthly fixed costs (mortgage interest, letting fees, insurance)
So here are some of the metrics that I use to 'benchmark' my property investments. However, measurement is of no real use unless:
a) we have a target to aim for and:
b) take some action if the result does not meet the target (the action could be to decide ride out a temporary storm however).
I do use one or two other metrics but these are my main ones that help me to decide on a good property to invest in and also to review the properties that I hold to judge how they are performing remembering that it can take several years for some of these metrics to really start to work for you properly...but property investing is after all a numbers game 🙂
Source & credits: The Telepgraph