As an aspiring landlord, you will no doubt have heard the words rental yields and capital gain, but what do these terms actually mean?
Even existing landlords may be slightly confused about the precise definitions of these terms, which is why we have put together some tips explaining all you need to know about two of the most fundamental parts of the lettings process, and whether one should be prioritised over the other for better returns…
What is a rental yield?
Put simply, a yield is the annual return you can expect to generate on the rental property you own through the rental income you receive. In order to calculate the rental yield, you need to be aware of the sale price or current value of your property and the rent you expect to receive for the year. The potential rental yield on a property is then estimated in the following way: you take the annual rent of a property, divide it by the home’s value and then multiply by 100.
If, for example, your property was valued at £400,000 and your annual rental income was £15,000, your yield would work out as 3.75%. Alternatively, if your property had a value of, say, £250,000 and your annual rental income was £12,000, your yield would be 4.8%.
The higher the yield, the better the return on investment. As such, buy-to-let landlords typically use potential rental yields as a way of determining whether or not a property is a good investment. Yields tend to be better in more affordable areas where tenant demand is high and good rents can still be charged, as the initial investment outlay is lower and yields are therefore less squeezed.
According to recent research (July 2019) by Kent Reliance, the average national yield on a residential property has reached 4.5%, a two-year high, while the average yield in London sits at 4.1%, a four-year high.
The above calculation is known as a gross yield. If you want to determine your net yield (the amount of money you actually take home), you’ll need to deduct all the expenses associated with letting a property from your annual rental figure before making the calculation. These expenses will include things like letting agent fees, landlord insurance and maintenance and repairs costs. You can read in more detail about what a rental yield is and how to calculate it here.
What is capital gain?
Capital gain, sometimes known as capital appreciation or capital growth, is also a key consideration for landlords. It is, in essence, a self-descriptive term - how much will your home increase in capital value over time? And how much could you get for your rental property if you ever come to sell in the future?
Capital gains have become a far bigger consideration for landlords in the last 20 years or so, as house prices have soared to record levels across the country.
Which one should you be prioritising?
On a basic level, landlords investing for the short-term should consider locations that could deliver high rental yields, while landlords with a long-term view may want to prioritise regions or cities with historical capital gains and steadily rising house prices.
It is possible, of course, for landlords to secure both strong rental yields and good capital gains over time – but there are no guarantees on this particular front. You should also be aware that rental yields and capital gains aren’t the only things to take into consideration when choosing where to invest. Tenant demand, how long rental properties stay on the market, and working out the sort of rent you can realistically charge are all just as important.
Easy access to town and city centres, local amenities, green space, good local schools and strong transport links are likely to make a rental property more attractive, so this is something you should also bear in mind before investing.
Rental yields are typically at their highest in commuter towns – particularly on the outskirts of major cities like London – as homes here are generally more affordable, tenant demand is high and there is a good opportunity to charge higher rents and secure reliable, long-term tenants.
If you have one eye on capital gains, you should consider up-and-coming areas which are likely to experience rapidly rising prices in the coming years. Or locations which have seen house prices rise steadily over a number of years, seemingly impervious to external factors.
You can never predict with 100% certainty what will happen to house prices moving forward, but you should typically be fine if you aim for areas where buyer demand is consistent or which have been the beneficiary of recent or ongoing infrastructure projects, for example Crossrail 1 or HS2.
We previously looked at the best property investment hotspots in the UK, which analysed some of the areas – including Coventry and Swansea – with the best average rental yields and strong capital appreciation.
The best locations for rental yields
Totallymoney.com’s UK Buy-to-Let Yield Map 2018/2019 suggests that the following locations offer the best rental yields in Britain.
- Nottingham postcode NG1, with a yield of 11.99% and an average monthly rental value of more than £1,500.
- Liverpool postcode L7, with a yield of 9.79% and an average monthly rental value of £941.
- Cleveland postcode TS1, with a yield of 9.45% and an average monthly rent of £543.
- Liverpool postcode L1, with a yield of 9.33% and average monthly rent of £923.
- Nottingham postcode NG7, with a yield of 8.89% and average monthly rent of more than £1,100.
Rental yields are typically much lower in London. Despite it being a hotbed of property investment and landlord activity, the prohibitive house prices in the capital mean landlords have to work much harder to turn a profit on their properties. Even the best London location for rental yields, East Ham, only has a yield of 4.81%, according to Totallymoney.
The best locations for capital gain
According to Simply Business, the best buy-to-let locations for capital gain are currently:
- Canterbury, 7.83%
- Sutton, 6.47%
- Coventry, 6.36%
- Stockport, 6.34%
- Stevenage, 6.15%
- Hereford, 5.60%
- Luton, 5.31%
- Croydon, 5.18%
- Northampton, 5.10%
- Southend-on-Sea, 4.89%
More information: for more info about Capital Gains Tax (or CGT) – which you’ll need to pay if you sell a property which has increased in value – our tips page on taxation rules for landlords can help. You can also find the latest UK rental data from HomeLet’s Rental Index.