What rental yields won’t tell you about Buy-to-Let returns

Buy-to-Let returns

It always makes for good headlines when a lettings index releases national figures comparing rents and yields across the country. And this quarter’s figures from Countrywide are no exception. But how much can such figures really tell us about the relative attraction of Buy-to-Let returns in different parts of the UK?

If your customers based their Buy-to-Let investment decisions solely on rental yields, they would be shunning properties in Central London and the South East and all flocking to Wales, where yields at 6.6% are the highest in the country. It’s not happening though, because rental yield doesn’t necessarily drive where your customer will look to invest.

This isn’t to say that rental yield is irrelevant. Indeed, the Countrywide figures show why it’s so important for Buy to Let investors to look at yield figures rather than simply the amount of rent they can charge.

Higher rents do not necessarily result in a more profitable investment

Gross rental yields show the annual rental income that a landlord will receive as a percentage of the purchase price of the property, and therefore the contribution that rental income will make to the profitability of a landlord’s investment.

Higher rents do not necessarily result in a more profitable investment, since higher property prices in the areas that command such rents tend to keep yields down. In Central London, for example, rents are double that of other regions, but yields are the lowest in the country.

Rental cash flow represents only part of the story

However, it’s important to remember that rental cash flow represents only part of the story – and only one of the ways in which landlords can generate a profit from the property they invest in. The second route to profitability, capital appreciation, can suggest investing in very different types of property – and in very different areas. Ignoring it can be just as damaging as ignoring yield.

With property prices in Central London and the South East now outperforming substantially those in the rest of the country, the benefits that landlords in these areas gain through increases in their property’s value can more than offset the lower rental yield that property generates on a monthly basis.

If landlords leave property prices out of the picture when working out how their investment adds up they are missing a vital piece of financial context – and could overlook some major investment opportunities.

There’s huge value in knowing the area where a property stands

There are other, equally valid reasons why a prospective landlord might want to invest in an area that seems less impressive from the yield figures: there is huge value in knowing the area where a property stands, the likely tenants and how to market to them.

Many landlords also feel more comfortable being physically closer to their investment and able to keep an eye on things; and others may plan to rent to friends or family, or pass the investment property onto their children at a later point. These intangible factors can’t be quantified as percentages in the same way that yields can – but they are no less significant for many landlords.

The real value is in balancing a consideration of rental yields with other factors

Predicting which areas will see the highest price growth can be difficult, however, and capital appreciation is harder to assess than yields based upon current rents. Prices can also go down as well as up, so a strategy based upon assumed appreciation and minimal rental yield is potentially just as incomplete as one based solely on yield.

For these reasons, there is real value in balancing a consideration of rental yields – which are still important in working out monthly cash flow –with other factors that influence the real value of an investment for each particular customer in order to get the fuller picture of any Buy to Let investment.

(Blog courtesy of The Mortgage Works)