Property Finance
Before committing to an investment loan like this, it is advisable to review your current and long-term situation and make sure that you know exactly what you are getting yourself into. You should ask yourself:
Can I afford to lose money/take a loss if the housing market slumps?
Will taking out a mortgage on this property affect my chances of getting a mortgage if I decide to move to a new house at a later date?
Calculating Your Return
When buying rental property, it is important to know how to calculate the return your investment will make. You should always make an appraisal of any investment before you go ahead to make sure it’s worth your while.
When calculating rental yield values you can also examine the effect that borrowing has on your potential returns, e.g. between buying a property for cash or using a buy to let mortgage to fund the purchase.
How much you decide to borrow also depends on your attitude towards risk as we all know that interest rates can go up as well as down. It’s really a matter of personal preference and how you see the local economy and cost of borrowing for the future that will influence your investment decisions.
Let’s look at a simple rental yield calculation...
Purchase @ £150,000
£700/mth rent
£8,400 annual rent
8,400 ÷ 150,000
x 100
_______________
5.6% Annual Yield
Say that you purchase a property for £150,000 and you receive rental income of £700 per month from your tenant. The yield calculation would be as follows. £700 x 12 = £8400 per annum rental income. (8,400 ÷ 150,000) x 100 = 5.6% Annual Yield
So simply put, yield is the return on your investment expressed as a percentage of what you put in (i.e. If you invest £150,000 and you receive £8,400 in profit/income per year, then £8400 is 5.6% of £150,000.) This example has been put very simply without factoring in any property maintenance costs insurance and doesn’t include any mortgage payments
Mortgage costs are calculated as follows...
So let’s look at calculating yield with a mortgage & associated costs. Let’s say you purchase a property for £150,000 but this time you use a buy-to-let mortgage and have to pay for the property insurance and some maintenance costs. The following are the figures we can use to calculate the yield value. Purchase costs: £1000 (including solicitors fees and insurances etc) and a deposit at 20% = £30,000
Purchase @ £150,000
80% LTV @ 5.5%
£150,000
-£30,000
(cash - deposit)
______________
£120,000 mortgage
£120,000
x 5.5%
______________
£6,600/yr (£550/mth)
£700/mth (rent)
- £550/mth (mortgage)
______________
£150/mth profit (£1,800/yr)
£1,800 ÷ £31,000
x 100
_______________
5.8% Annual Yield
The gross profit would be £700 rent – £550 Mortgage = £150 gross profit per month. So £150 x 12 = £1800 per annum.
Now we have these figures we can now calculate the yield value as follows. Amount invested so far is: £31,000 (deposit + costs) so an annual gross profit is £1800. (£1,800 ÷ £31,000) x 100 = 5.8% yield value on cash amount invested.
A £150,000 property (purchase price) with a 80% LTV (loan to value) interest only mortgage at an interest rate of 5.5%. £150,000 – £30,000 = £120,000 mortgage monthly repayments are: £120,000 x 5.5% = £6,600 per annum. £6,600/12 = £550 per month.
Cash versus Finance.
Looking at these figures you could have bought 5 properties secured on a buy to let mortgages with a £150,000 investment and receive £9,000 in gross rental profits compared to £6,600 using the cash to purchase one rental property. Because you can now buy 5 properties you will own a larger amount of assets (£750,000) so you will also get greater capital gains if the house price was to rise in the future. If the property rises in value by 10% over the first five years then your five properties will have given you a “value” increase of £75,000 when the one property will have increased by only £15,000. If you factor in the capital gain then your percentage return is significantly increased. For example if your return against rent is as above but you then factor in a 5% annual property price increase (£150,000 x 5%) this gives a value increase of £7,500 per annum. This is then added to the rental income so annual rent after costs (£1800) plus value increase (£7,500) gives an annual income of £9,300. Take this against the value of the investment (£31,000) gives a percentage return of 30%!