Buying BTL properties is usually both exciting and nerve wracking, especially for a first-time landlord. Trust me, I’ve been there. The thought of investing so much money into a BTL property is a very scary prospect, and it seems risky. What if it all goes wrong? What if I lose all my money? Sound familiar?
In reality, investing in property really isn’t THAT risky- not in the grand scheme of things anyways. It’s extremely unlikely that you’re going to wake up one day and find that your property is worth zero. Of course, the property market goes through highs and lows, busts and booms, but that’s the natural cycle, and sometimes you just need to ride it out.
The key to a successful BTL investment is buying the right property. That’s all it is. Now, that may sound simple, but it really isn’t. There are many variables to consider, and there’s dozens of attributes that make a property worth investing in, such as crime rates, local schools, transport links, employment rates etc. All these factors, among others, have influence on returns and growth.
But essentially, as with all investments, you’re trying to achieve the best ROI (Return On Investment), and with rental properties, there are several ways to calculate your (potential) ROI.
Calculating Rental Yield: The Formula
Calculating rental yield is generally used to forecast the potential ROI on two properties, in different investment areas of the country or even, in different parts of the same town. It is a useful way of comparing two property deals and forecasting which is the better deal for you.
It is a simple calculation dividing the agreed purchase price by the annual rent and expressing the answer as a percentage
The formula is: monthly rent x 12 / agreed purchase price x 100 = Rental Yield%
For example for a property that you could purchase for £100,000 and you expected to rent it for £650 per month the rental yield would be:
£650 x 12 = £7,800 / £100,000 = 0.078 x 100 = 7.8%
Compare that to a similar property that you could purchase for £200,000 and you expected to rent it for £950 per month the rental yield would be:
£950 x 12 = £11,400 / £200,000 = 0.057 x 100 = 5.7%
From the examples above, the first property, although a lower initial investment will offer a higher return. At the second property you would need to seek rent of £1,300 a month to reach the same rental yield as the first property. Of course this formula doesn’t take into consideration times when the property is empty but it does help you to judge which properties are likely to give a better long-term return.
Simple!
It is worth noting that in the US they often calculate rental yield differently. They will calculate the annual rental income over the property value. This is usually done post purchase and after any refurbishment has been completed.
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Calculating Return On Investment: Before Refinance
To calculate ROI before refinance you will first need to calculate the annual cash flow or monthly gross profit. This is monthly rental income less the mortgage repayment, insurances, agency fees and other expenses like utilities if they are included in your tenant’s rent. Divide this by the initial investment. Which for a cash purchase is the full agreed sale price plus all fees like stamp duty, surveys, legal fees and sourcing fees. And for a mortgage purchase is the deposit plus all the same fees.
The calculation is: (Monthly rent – Mortgage amount, agency fees, bills, insurances etc.) x 12 / your initial investment (either full agreed sale price or deposit + all fees) x 100 = ROI Before Refinance
£650 – £234 = £416 x 12 = £5,000 / £50,000 x 100 = 10%
You could include tax to calculate your Net Profit. How much tax and when this is added to the calculation depends on whether the property is purchased in a company or personal name.
Calculating Return on Investment: After Refinance
To calculate ROI after the property has been refinanced you begin by calculating the annual cash flow in the same way as above. Then you divide it into the money that is left in the property or the amount that the property owes you.
To do this, you will need to calculate your Loan to Value percentage (LTV). This is how much of the value of the property is ‘owned by you’ and how much is covered by your bank loan. Quite often this is 75% loan to 25% deposit or 75%LTV.
The LTV calculation is: Revaluation amount x LTV
£200,000 x 75% LTV = £150,000.
In this example, if the purchase price + fees and refurbishment (initial cash outlay) is less than £150,000 then there is no money left in the property. The property owes you nothing. The ROI is infinite as you are using money created from nothing to generate your annual cash flow. This is the ideal situation for landlords to be in.
However, if the initial cash outlay is more than £150,000 then there is money left in the property and this is used to calculate the ROI.
So the calculation is: Annual cash flow / (initial cash outlay – (Revaluation x LTV)) x 100 = ROI After Refinance
£5,000 / (£180,000 – (£200,000 x 75%LTV = £150,000) = £30,000) x 100 = 16.66%
In summary then, calculating rental yield is a useful forecasting tool to compare two properties, to estimate which will give the better long-term return. ROI gives a more accurate figures based on annual income against investment or money left in the property.
You can see this in more detail by downloading our Mill Road Deal Stacker.
