Why not use rental yields to decide your investments?

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While the headline from any particular property market will involve property price movements, why should it all revolve around prices? This may sound something of a bizarre comment but if we look at rental yields then surely we can use these as a barometer as to whether a property offers good value? Stay with us, and we will take a look at this particular investment strategy in more detail.

Steady rental income

If you buy a property for £100,000 and it creates rental income of £10,000 per annum then your gross rental yield is obviously 10%. If the property increases in value to £200,000 and your rental income is still £10,000 per annum the rental yield would then be 5%. You still have the same income but as a percentage of the value of the property it has halved. So, let us use this idea in a different way to work out the optimum purchase price for a property you have your eye on.

Rental yield is the key

If you believe that a rental yield of 10% should be achievable in a particular area then you need to look at the value of properties and potential rental income. If for example a property is valued at £150,000 and attracts a rental income of £10,000 then this equates to a rental yield of 6.66%. If your target yield is 10% then the price of the property does not fit in with your strategy. While these price changes may be a little extreme, what if the value of the property fell to £100,000 and the rental income remained static at £10,000 per annum?

This would effectively fit in with your criteria of a 10% rental yield even if the value of property in the area had fallen. The extreme figures we have used in this example are unlikely to occur in everyday life but they do give an example of how the potential rental from a property can dictate what price you want to pay.

Other factors to take into consideration

Obviously you would need to take into account why the property had fallen in value, the demand for rental property in the area as well as your own finances. If the longer term potential for the area and the type of property remains intact, and you can achieve your optimum rental yield, this could be a property to buy and lock away.

In this instance we have not taken into account annual increases in rent which should in theory at least match inflation to maintain the real value of your income going forward. There are also specific costs associated with owning a rental property but again for ease of comparison we have not taken these into consideration.

Conclusion

If you have a long-term plan to create a buy to let portfolio generating a specific rental income then in many ways the rental yield of a potential property purchase will dictate your course of action. That is not to say you should automatically go ahead when your optimum rental yield is achieved but this would perhaps be a good opportunity to do more in depth research and see if the longer term picture is positive.

At the end of the day, in this instance, if you have a 10% rental yield on your property then in reality you would have paid back your investment in 10 years. In real life it would be slightly longer bearing in mind additional costs associated with a rental property and interest charges but this should give you food for thought.

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