Calculating The Rental Yield To Find The Best Investment

As a landlord, or more specifically, perhaps a new/upcoming landlord, have you ever been torn between multiple properties? A landlord’s main concern should be buying the property which will offers the best ROI (Return On Investment). Perhaps an important aspect many landlords don’t pay enough attention to, as they’re too busy focusing on the superficials. While that’s not a terrible thing, it’s important to remember why you’re buying the property in the first place- for an investment; to make money! So you want a property that will make you the most income! So how do you work that out?

Example scenario
John wants to be a landlord, so he’s on the hunt to buy a property. John has seen 2 properties he likes. Property 1 costs 150,000 with a potential rental return of £600pcm. Property 2 costs £180,000 with a potential rental return of £775pcm. Which is the better buy?

This when is calculating the “rental yield” will help.

What is rental yield?

Yield is a way of calculating the ROI on your BTL; it uses the rental income over the initial cost of buying the property, and is usually expressed as a percentage.

There are different ways of calculating yield, but in our case, we’re going to use the most common for BTL: the ‘rental yield’ is the total amount of rent minus the running costs (mortgage payments, insurance, repairs and maintenance etc.), divided by the total amount invested to purchase the property (that should include all fees, including tax and legal fees).

The higher the yield, the better.

Calculating rental yield

The formula:
mrr = monthly rental return
i = investment

Yield = mrr*12/i*100

Rental yield for Property 1

Monthly rental return = £600
Investment = £150,000

£600 * 12 = £7,200
£7,200 / £150,000 = 0.048
0.048 * 100 = 4.8 % yield

Rental yield for Property 2

Monthly rental return = £775
Investment = £180,000

£775 * 12 = £9,300
£9,300 / £180,000 = 0.0516
0.0516 * 100 = 5.16 % yield

Conclusion

Although property 1 costs less to buy, property 2 offers the better ROI. However, it’s important to note that the yield can change over the duration of the investment, as house prices change.

What is a good return yield percentage?

Well, it’s actually a subjective issue. I personally think any property which has a return yield of 7%+ is extremely good. I certainly wouldn’t put my nose up at a property which generates that kind of yield.

To make life easier (because that’s what I’m all about), you can use the calculator below to calculate your yield…

Rental Yield Calculator
Rent per month (e.g £750)
House price (e.g £150000)
Rental Yield

Points to remember

While calculating the yield of a BTL property is relatively straight forward, there are a few points to consider:

  • Void periods – ignoring void periods is a common mistake, and if you fall victim it can easily skew your calculations. When calculating the yield, bear in mind that it’s unlikely you will always have a occupied property for 12 months of the year, so the total income won’t always be 12 months x £Monthly rent. There maybe times where you will have void periods, whether it be in-between tenants or at the very beginning of your investment. So you may want to “stress-test” your calculations by using 11 months’ worth of rental income.
  • Rent – If you’re in the midst of your research phase, and you don’t know how much rent your prospective investments can achieve, you can look on portals like Rightmove, Zoopla and Guntree to see what other similar properties in the same area are demanding. Alternatively, you could talk to a local letting agent. However, bear in mind, the “asking price” isn’t always the amount achieved.
  • Total costs – when calculating your yield, it’s important to use the real figures to get the most accurate calculations. So when using the total investment amount, it should include ALL your costs, which may include the following:
    • Cost of property
    • Tenant acquisition
    • Insurance
    • Mortgage product/arrangement fee
    • Solicitor fees
    • Survey fees
    • Any other legal fees
    • Cost of redecorating/maintenance
    • Running costs during void periods (e.g. council tax, utility bills)
    • Costs of furniture/white goods
  • Be wary of yield calculations – when you hear agents or developers talk of yields they can often sound incredibly attractive, and this is when you should start asking questions. They often make their calculations based on basic cost of the property and essentially ignoring all the costs associated with buying the property (as per the list mentioned above), which obviously skyrockets the yield and makes the deal seem sweeter than it actually is! Buyer beware!

Top 50 Buy-to-Let Hotspots by Rental Yield in England & Wales

HSBC has released a report showing the average rental yields for the top Buy-to-Let hotspots of England and Wales based on data from the Office of National Statistics (ONS) and Land Registry.

While these are only averages, and don’t account for ‘special cases’, which include high-yielding gems, it does give a good indication where the highest yielding areas are.

The following data was published on the 30th May, 2014.

LocationPercentage of Rental Housing StockAverage House PriceAverage Rent (Monthly)Average Rent (Annual)Rental Yield (gross)
Southampton23.42%£138,311£901£10,8127.82%
Blackpool24.16%£75,943£494£5,9287.81%
Kingston upon Hull19.02%£69,519£450£5,4007.77%
Manchester26.85%£102,631£650£7,8007.60%
Nottingham21.64%£83,313£524£6,2887.55%
Coventry19.02%£104,970£624£7,4887.13%
Slough23.07%£171,581£975£11,7006.82%
Oxford26.11%£244,893£1,375£16,5006.74%
Liverpool21.75%£91,012£498£5,9766.57%
Portsmouth22.28%£141,971£775£9,3006.55%
Cardiff20.32%£140,882£75090006.39%
Cambridge23.91%£179,699£949£11,3886.34%
Southwark22.22%£401,405£2,058£24,6966.15%
Luton21.27%£127,473£650£7,8006.12%
Newham32.62%£229,141£1,126£13,5125.90%
Leicester21.28%£112,226£550£6,6005.88%
Bournemouth28.21%£170,493£825£9,9005.81%
Enfield21.18%£261,163£1,200£14,4005.51%
Brighton and Hove28.04%£229,622£1,049£12,5885.48%
Brent28.82%£337,723£1,517£18,2045.39%
Forest Heath21.80%£179,699£795£9,5405.31%
Torbay21.43%£139,168£598£7,1765.16%
Southend-on-Sea20.72%£152,171£650£7,8005.13%
Watford18.89%£240,239£997£11,9644.98%
Bristol, City of22.11%£169,425£695£8,3404.92%
Kingston upon Thames21.04%£333,122£1,363£16,3564.91%
Reading24.68%£196,309£795£9,5404.86%
Hounslow22.23%£285,927£1,148£137764.82%
Wandsworth30.02%£428,987£1,694£20,3284.74%
Lewisham22.97%£283,031£1,101£13,2124.67%
Shepway20.17%£181,399£695£8,3404.60%
Tower Hamlets30.84%£364,296£1,387£16,6444.57%
Eastbourne21.65%£177,408£675£8,1004.57%
Harrow20.37%£306,381£1,148£13,7764.50%
Croydon19.83%£254,591£949£11,3884.47%
Exeter19.56%£187,680£693£8,3164.43%
Isles of Scilly20.63%£180,227£654£78484.35%
Lincoln19.36%£119,076£429£5,1484.32%
Redbridge21.63%£292,459£1,049£12,5884.30%
Cheltenham20.15%£170,573£598£7,1764.21%
Ipswich18.75%£153,163£524£6,2884.11%
Richmond upon Thames20.55%£485,496£1,647£19,7644.07%
Westminster37.56%£767,112£2,578£30,9364.03%
Norwich20.10%£179,699£598£7,1763.99%
Camden30.46%£646,043£2,145£25,7403.98%
Hastings27.19%£177,408£550£6,6003.72%
Haringey30.33%£372,278£1,148£13,7763.70%
Thanet21.96%£181,399£524£6,2883.47%
Hammersmith and Fulham30.05%£593,787£1,690£20,2803.42%
Kensington and Chelsea33.97%£1,090,943£3,033£36,3963.34%

Like this post? Then maybe you should sign up to my FREE newsletter so you receive more like it!

83 Comments- join the conversation...

Showing 33 - 83 comments (out of 83)
Guest Avatar
John 19th March, 2015 @ 23:49

Good morning Guy.
The way you explain is beginning to make sense, and Indeed the penny is on the edge, if my roof does fall in then it's going to cost me big time, and to be very honest the roofing felt is very brittle with a few holes, as I said earlier , I have kept my rent low as to keep my tennants , and to be honest after long thought, in the long run its me who will be the loser if that happens, the tennants will just move to nice warm and dry nest and will leave me with the bill.
I am quite handy with many types of repairs, and do now have a small roof repair to do, just a trowel full of concrete will do it, while I got the ladder there I will clean the guttering and sofit boards, when this is done it is my intention to put up the rent, as I have been thinking about it for a while, as the going rate for an equivalent house is around 775-800 per month, I suppose Iike you have made me realise, I do have a big risk of losing a big chunk of everything I have made, and it's ok for me at the moment as I am rolling in the money, but this really could happen, I need to look at the bigger picture..... thanks Guy...I want you to know I am listening and learning from you.

33
Guest Avatar
Captain Hook 20th March, 2015 @ 12:30

Sorry Guy, I'm not arguing theory with you, Modigliani or Miller!
I'll have a go at practice against theory though.

You have made two slightly different statements which highlight this;

How an investment is financed makes no difference to its rates of return.

Which I agree.

The profitability of the investment is not affected by the way it's financed.

My understanding of 'profitability' is the amount I put down on my tax return each year.

Paying 2% mortgage or 20% mortgage, 100% LTV or 0% LTV, finance offset against tax of 0% or 40%, all affect the profitability (and the opportunity costs).

34
Guest Avatar
Captain Hook 20th March, 2015 @ 12:46

I'd also like to point out that property is not a pure 'investment' (at least, not in the way I do it!).
There is a large element of it that requires work.

Halfords shares don't phone you up at midnight requesting urgent repairs!

35
Guest Avatar
Guy Knapton 20th March, 2015 @ 13:46

John:
Am off to my wife's home town, Berlin, for the weekend. I'll post more stuff on Tuesday, which I hope will help you a little. Till then, thanks for your kind words, GK

36
Guest Avatar
Rob 21st March, 2015 @ 09:16

Hi, as property rises in value so your yeild decreases. Can u factor in a rent increase to take the value of the property into consideration?? If so how? Rob

37
Guest Avatar
Uche 23rd March, 2015 @ 22:58

Quite interesting perspective to property investment from the comments above

38
Guest Avatar
Guy Knapton 24th March, 2015 @ 11:47

Morning Rob:
Good question and not hard to answer. To your first question: yes, to which I would add that it is vital to do so for reasons given in answer to your second question.
First, please spend some time to know and understand the excellent data provided, free, by Nationwide. Try here and look around: http://www.nationwide.co.uk/about/house-price-index/headlines
Then, be sure you understand the difference between nominal prices and real prices. Nominal prices are the prices quoted daily/monthly/annually. Real prices are these prices adjusted for the rate of inflation. This changes over time; differs from region to region; and from sector to sector. For excellent stuff on the effects of UK inflation try here: http://www.measuringworth.com/ukcompare/. For great stuff on the effect of inflation on UK average house prices since 1975, try here http://www.housepricecrash.co.uk/indices-nationwide-national-inflation.php. This site uses Nationwide data, the original of which you can find easily but in Excel format.
Over forty years the average annual increase in price of the average house in the UK has been a snitch under 3%. These averages conceal differences that should not be ignored. However, on average, over the life of the property, to maintain the rental yield on UK property, rent increases should average about 3%/year.
Now I know that rent increases may not be easy to put into practice. It must be easier to increase rents annually in small amounts than seldom in big ones? The Nationwide index is an objective standard that most tenants should accept more willingly than some arbitrary guess! Anyway, for landlords, the simple fact is that, in the longer run, yield will decline if real rental income is not maintained. Failure to do so can even be ruinous.
A question. Are you satisfied that your present rental income as a percentage of the present market value of your property is about right? If it's less than 6%, you may have some catching up to do: ugh! If it's 8% or higher, you're doing well so try to stick with it without becoming too greedy -- geese and golden eggs and all that :) Solvent, loyal, respectable tenants paying a fair rent on time are worth their weight in gold: involuntary voids, bad debts, reckless damage, and litigation are hideous.

39
Guest Avatar
John 24th March, 2015 @ 12:56

thankfully I don't suffer any of the hideous items in the last paragraph...and I agree..it's better not to be greedy, I thought I might put my rent up 50 as I haven't increased in six years, but I've thought long and hard and am going to be a nice landlord and treat my nice, clean and tidy tennants in a way they deserve , I know I could get more and the going rate is more, well...the ones on the "for rent" websites are asking more....this is the reason they aren't occupied....greedy landlords.

40
Guest Avatar
Robert 26th March, 2015 @ 15:54

Hi Guy,

I am looking to invest my personal pension pot into buying a property and renting it out with the aim of getting a return of around 6% per annum based on £85000 purchase and rental income £450/month after agent fees + Insurance. The annual return is around £5400.

If I keep the property for 10 years I would hope that the sale of the property would also return a reasonable profit but would no doubt be liable for tax.

I am a coward when it comes to gambling but would ask if you consider the above to be a wise choice?

Any comments (clean only) would be welcome?

//Regards

41
Guest Avatar
John 26th March, 2015 @ 17:00

#Robert.
when I first started with my rental six years ago, I just put an advert in my local journal for two weeks but found my tennants in just one day, I got the local letting agent to do the tenancy agreement and inventory, sorting everything for a one off fee of approx £100, this keeps the costs down if you manage it yourself.
As for buying a property then depends on wether you need your pension money for other things, if it's surplus money then go for it, if you are lucky enough to find some sensible tennants like I did then you can't really go wrong....that said...I've recently been watching my pension pots and they seem to be doing very well at the moment, I have two pension pots total value 56k, I registered and got an online account so I can look at their value, over the last two months they have risen 2.5k , last week alone I saw a rise of £460, so worth checking this out, as your money might be better off left in your pension for now, worth checking up on anyway....good luck....!

42
Guest Avatar
John 26th March, 2015 @ 17:20

#Guy.
I drove over to my rental today to inspect the roof, seems ok apart from I ended up cleaning the guttering and facia boards, nothing my powerful power washer couldn't handle, although I need to go back now and back and paint them, power washed the path ways and patio while I was at it, fixed the shed roof and treated the front fence with some wood preservative, anyway, being able to do all these minor jobs is all good for your pocket, as it can be expensive if you have to pay other to do it.
I did have a little look at the halfords shares you mentioned and they seem to be a good buy at the moment, well, according to the experts....I've been thinking for a while I would like to have a go myself but don't know a lot about it, I could maybe just start off with a few hundred quid and see what happens, as I think you have to have a little bit of a gambler inside you if you buy big, and I don't know if I would have the nerve....

43
Guest Avatar
Guy Knapton 26th March, 2015 @ 22:43

Robert:
I'm flattered that you think I'm qualified to advise you on an interesting proposal. Thank you.
Sadly, I'm unable to give you wise enough advice. Nor do I know enough about your circumstances or your wishes to give you reliable advice. And: not living in the UK I'm insufficiently familiar with UK tax and other significant aspects of the likely consequences of your proposal.
On property as an investment John's advice will be more helpful than mine. If I may balance his knowledge and enthusiasm for property, here are some issues for you to weigh:
1. What is it about your present pension arrangements that dissatisfies you? If it ain't broke, why try to fix it?
2. How sure are you that your annual rental income will be £5,400 for ten years? I advise you to be more prudent by assuming ten months' rental income per year: you can expect voids/bed debts/repairs & maintenance/litigation.
3. Why would a yield of 6% before tax be an acceptable rate of return for you? It would be easy to recommend to you a £1.2bn High Income Unit Trust yielding over 7%/year. (I can't do so: I'm not a qualified financial adviser!) Unit Trusts don't need maintenance; not all 102 companies in the FTSE Index will go bust!
4. It's generally considered wise not to put all one's eggs in one basket, including in property. Have you a sufficiently diversified portfolio of assets to weather the inevitable market ups and downs? Real prices of UK houses in 2014 Q4 (£189,002) are way below their peak in 2007 Q3 (£228,986). Property investment is not risk-free, nor is it especially liquid -- it's subject to potential losses and is not immediately realisable.
5. I'm all for property, especially for living in, but the cost of investing in it are all the benefits you forego by not investing in something else. This trade-off is too often ignored; alternative investments are not properly evaluated; and the return on property investment is too easily exaggerated by not using real monetary values.
6. Many people do well with property. Too many lose their shirts but they don't make the headlines, so we ignore them.

44
Guest Avatar
Guy Knapton 26th March, 2015 @ 22:51

John:
In haste. Don't buy shares in Halfords, for goodness sake! I'm not qualified to give investment advice. I was only citing one stock I happen to own as an example. not as a recommendation. Buy any stock you like but only if you've taken advice from a reputable, qualified financial adviser you know and who knows you.
If I were you, I think I'd stick to property. But even this is only a thought.

45
Guest Avatar
John 26th March, 2015 @ 23:03

it was never my real intention to do so Guy, I think I'm going to keep my money and save it, if I was ever to buy shares it would be mulberry (mul) it's a high end leather goods company I worked for for fifteen years, if I had more knowledge about buying I'm sure I could make a killing.

46
Guest Avatar
Robert 27th March, 2015 @ 12:13

Hi Guy,
Thank you for your email..

In answer to:-
Q1: My pension savings are held in a buiding society with little yield at present. These savings are not making suitable return and eventually my 'non-sustainable pot' will begin to diminish as I draw from it, when I take retirement.

Q2: This was an assumption - naivety on my part after reading the rest of your comment.

Q3: It seemed a better return than present and with no experience of stocks & shares I felt this would be a more suitable venture.

Q4: I agree..

The remainder are understood and I thank you for your comments.. Like many people, I am wary of the future, especially in retirement and I was looking for a suitable investment that would provide sustainability and future inheritance for my children. High Income Unit Trusts may be a better investment, I will discuss this further with a Financial Advisor.

Regards//

47
Guest Avatar
Benji 27th March, 2015 @ 12:44

@Robert,

I will discuss this further with a Financial Advisor.

Bear in mind that no commission based financial advisor will advise you to invest in property.

It is a bit like asking an estate agent if you should invest in unit trusts or property.

48
Guest Avatar
Guy Knapton 27th March, 2015 @ 15:34

Robert:
FWIW, I doubt if a bank or BS is a wise choice of destination for your pension pot. In spite of the BoE's recent statement on UK inflation, I bet your (personal) rate of inflation is gnawing away at the principal.
To repeat, I'm not qualified to give financial advice so what follows is only how I meet the challenge of a decent retirement: it's not, repeat not, a set of recommendations. Just thinking aloud?
For a rainy day, I have some dosh in Premium Bonds. They pay 1.35%/year and no tax: I just like a no-risk gamble offering the possibility however remote of a neat windfall. Winnings of £25 come my way regularly. I think it's a cool way of ensuring that, in case of an emergency, I can get my hands on some ready cash.
It's important to decide what one wants from investment. Safe-as-houses; high capital appreciation; and high income investments are a figment of our imagination. Investments that increase strongly in value seldom have high running yields: high yielders seldom gain strongly in value. Renishaw has done me really well but pays peanuts, 1.85% at yesterday's closing price. My Vodafone are down but they pay a cool 5.49% and I believe it's a quality stock. I like 'em all and I have a few more that together yield 4.43%/year and that are 23% up over five years, a gain of about 4%/year. I judge a total yield before tax of about 8%/year to be not too shabby for someone on the wrong side of retirement age.
I can do some really dumb things, though. Trading is the dumbest: trying to outsmart the market. Me? Outsmart the market? Dope! If I leave it alone, it does the business much better. I followed financial gurus and bought into a great brand with a 100+ year history and a turnaround under way. Hello HMV and there goes my modest stake down the toilet in less than two years. Dope! And I could go on but I won't.
For me and, by the sound of it, for you too, a good bet has to be a UK index-tracking Unit Trust or ETF. These beasts are usually big; they're invested (mostly) in UK Plc; and they mostly do what's on the tin. On one of my tins it says "Schroder Income Maximiser" http://www.schroders.com/getfunddocument?oid=1.9.43020. It's held up well without being spectacular (so it'll never make me rich but I'm not over-bothered), and yields a juicy 7.77%. Of course, its price can go up and down in the short term, which also doesn't bother me, but over ten years or more the value of the fund just will increase if I don't mess with it, and it satisfies my real purpose for it: income, income, income. With dopey exceptions like HMV I buy stuff for a specific purpose that I can check out later -- eg Renishaw (growth) and Schroder (income).
That's my ten cents worth, Robert. Proceed with caution, but fortune favours the brave (my school motto). If you find a place for your pension funds that pays loads more than 7-8% at equivalent or lesser risk, please be kind and let me into your secret -- a secret I could easily keep:)

49
Guest Avatar
Benji 27th March, 2015 @ 16:56

@Robert,

I'm not a financial advisor either but here is my 10 cents worth for consideration (using my personal risk level).

Split your pot roughly into 3.

1/3rd in low risk premium bonds/ building society (tax free, post budget).
1/3rd in medium risk FTSE tracker ISA (tax free).
1/3rd in high risk £85000 rental property, financed thus-

35% deposit (£29750)+ transaction costs (high!)
65% loan to value, 5 year fixed rate, interest only BTL mortgage @3.89% from TMW (other lenders exist).
You can take out a BTL mortgage up to age 70 years old with TMW, potentially taking you to 95 years old before expiry.

£5400 pa rental income (check & re-check this) minus £2150 pa mortgage interest payment- Guy can baffle you with financial science on the return of that.

Rents/house prices will, more likely than not, increase over the medium to long term.

Landlording is more of a 2nd job than an investment, study it for a few months before taking the plunge and join the RLA or NLA. Don't rush into buying.

Other factors to consider are your personal tax situation. Rental income is taxed at your income tax rate.
Capital gains tax is payable on gains over £11000, currently.
If you have a (trusted!) wife/husband/long term partner, look into putting the property in joint names.

Do your own research, when you think you know it all, do it all again!

50
Guest Avatar
Guy Knapton 27th March, 2015 @ 18:20

Good thinking, Benji, especially the "2nd job" comment. It's so easy to believe about property investment what we want to believe and not what the facts about it are actually telling us. I know no way of making profits easily or without risk. The main risk in BTL is the security of the tenant's income, and that's pretty risky.
May I take advantage of your thread by passing on to Robert some financial numbers that I forgot in an earlier post. If he were to invest his pension in a property bought for £85K, in ten years time it would be worth about £110K [£85,000*(1.027^10)], if real house prices continue to rise over the next ten years as they have, on average, since 1973. As the price of the property he has in mind is less than half the present average UK house price of about £190K, its price in real terms may rise more than the long-term average of 2.7%/year owing to increased demand from buyers unable to pay exorbitant prices.

51
Guest Avatar
Mark 2nd April, 2015 @ 23:45

Lots of interesting comments and some useful info. Thanks everyone. I am a property investor/developer and have regular access to many below market valued properties from various sources. The challenge is that other people have access too so time is the essence doing due diligence and running all the numbers to see which deal is worth moving on, quickly I might add. I have created a fantastic tool that I use for giving me all the bottom-line numbers so I know if a deal is worth it, or not, quickly and hopefully ahead of my competition. I enter purchase price, market value, any renovation costs, legal fees, ground rent and service charge costs if applicable, etc. My results show me immediately what my ‘real’ returns will be taking into account every single imaginary cost including working out any SDLT due too and agents costs if flipping the asset. Any of the inputted values can be manipulated on the fly to see how the results can be changed, if wished. i.e. changing mortgage interest values and amending the rent up or down to see what returns can be achieved etc. I am going to make the tool available for a very small fee and I’m also working on producing an App later (it has been started). The spreadsheet is work-in-progress at version 1.25 and almost perfect. It would be great gauging any interest now please so I would love to hear and receive feedback about this tool on this site or send personally via email if my email address gets published here. Cheers Mark (mark@red3.co.uk)

52
Guest Avatar
Mark 2nd April, 2015 @ 23:48

Lots of interesting comments and some useful info. Thanks everyone. I am a property investor/developer and have regular access to many below market valued properties from various sources. The challenge is that other people have access too so time is the essence doing due diligence and running all the numbers to see which deal is worth moving on, quickly I might add. I have created a fantastic tool that I use for giving me all the bottom-line numbers so I know if a deal is worth it, or not, quickly and hopefully ahead of my competition. I enter purchase price, market value, any renovation costs, legal fees, ground rent and service charge costs if applicable, etc. My results show me immediately what my ‘real’ returns will be taking into account every single imaginary cost including working out any SDLT due too and agent’s costs if flipping the asset. Any of the inputted values can be manipulated on the fly to see how the results can be changed, if wished. i.e. changing mortgage interest values and amending the rent up or down to see what returns can be achieved etc. I am going to make the tool available for a very small fee and I’m also working on producing an App later (it has been started). The spreadsheet is work-in-progress at version 1.25 and almost perfect. It would be great gauging any interest now please so I would love to hear and receive feedback about this tool on this site or send personally via email if my email address gets published here. Cheers Mark (mark@red3.co.uk)

53
Guest Avatar
kaye 16th June, 2015 @ 23:48

Sorry to have to say this. Your definition of rental yield is misleading. The formula used here computes an asset turnover ratio and not a yield figure. The asset turnover ratio is a measure of effectiveness, showing how much rent is generated by one pound invested in the property. A yield is a measure of profitability showing the net return earned from the monies invested. It is computed by dividing the net profit by the amount of capital invested.

54
Guest Avatar
Guykguard 17th June, 2015 @ 06:56

Don't apologize! Say whatever you wish even if what you say misses the main point!
The main point is to use measures of profitability that enable reliable comparisons to be made with the inescapable alternative uses to which the capital could be put.
John (above) estimates his property to be worth £185K. So e could sell it and invest the proceeds elsewhere -- I'm not saying he should! One criterion for his choice is likely to be the annual yield on his investment.
Two obvious alternatives to the property investment are stocks, especially Gilts for sterling investors, and shares. In all cases, the annual or running yield is expressed as the annual gross income, whether rent, interest or dividends, as a percentage of the market value today of the investment. Yield can change with every passing moment: we can read the yield on stocks and shares on dozens of websites and in our daily newspapers. This important information enables to judge, reliably, the wisdom of our present investments.
Your post suggests that you've studied some corporate finance? As a measure of efficiency, asset turnover is a number, calculated by dividing sales by total assets (AT=Net Sales/Total Assets). It's a useful measure but it has nothing to do with the debate above.
You prefer to use "capital invested" in the denominator. This suggests that you consider only the investor's stake in the investment, so excluding any mortgage or other similar finance? This is a version of "return on equity", which is useful in comparing business performance. In the cases in the debate above, this measure is unhelpful: how the investment is financed makes no difference to the yield comparisons, For these to be comparable, and so that we may allocate our funds wisely, we must assume the alternatives under consideration to be financed similarly or we're back in cuckoo land! How an investment is financed makes no difference to its rate of return (yield).
Never apologize, Kaye. Weigh in there and make your point! BTW: many if not most people would probably agree with you, but for most people financial analysis is still a mystery tour :(

55
Guest Avatar
Guykguard 17th June, 2015 @ 06:58

Don't apologize! Say whatever you wish even if what you say misses the main point!
The main point is to use measures of profitability that enable reliable comparisons to be made with the inescapable alternative uses to which the capital could be put.
John (above) estimates his property to be worth £185K. So e could sell it and invest the proceeds elsewhere -- I'm not saying he should! One criterion for his choice is likely to be the annual yield on his investment.
Two obvious alternatives to the property investment are stocks, especially Gilts for sterling investors, and shares. In all cases, the annual or running yield is expressed as the annual gross income, whether rent, interest or dividends, as a percentage of the market value today of the investment. Yield can change with every passing moment: we can read the yield on stocks and shares on dozens of websites and in our daily newspapers. This important information enables to judge, reliably, the wisdom of our present investments.
Your post suggests that you've studied some corporate finance? As a measure of efficiency, asset turnover is a number, calculated by dividing sales by total assets (AT=Net Sales/Total Assets). It's a useful measure but it has nothing to do with the debate above.
You prefer to use "capital invested" in the denominator. This suggests that you consider only the investor's stake in the investment, so excluding any mortgage or other similar finance? This is a version of "return on equity", which is useful in comparing business performance. In the cases in the debate above, this measure is unhelpful: how the investment is financed makes no difference to the yield comparisons, For these to be comparable, and so that we may allocate our funds wisely, we must assume the alternatives under consideration to be financed similarly or we're back in cuckoo land! How an investment is financed makes no difference to its rate of return (yield).
Never apologize, Kaye. Weigh in there and make your point! BTW: many if not most people would probably agree with you, but for most people financial analysis is, alas, still a mystery tour :(

56
Guest Avatar
Gabe 9th September, 2015 @ 09:36

Hello Guy
A quick question if I may for someone new entering into the buy to let market.
I have approx £55K to invest and would like to invest in a local buy-to-let property where I know prices can command approx £600 for a 1 bed up to £800/£900 for a 2/3 bed.
With small properties ranging from £80K to £200K should I simply buy as cheap as I can to keep my additional lending to a minimum or do I borrow more to try and increase the yield and my ROI.
Decisions, decisons, decisions...........
Any advice greatly appreciated.
Thank you

57
Guest Avatar
Guy Knapton 9th September, 2015 @ 15:31

Hello Gabe:
Many thanks for your questions. Unfortunately you catch me at an especially hectic time. It's even my birthday today so I may not be able to answer you until next week. Sorry, I hope you can wait and that someone else better qualified than me can help you sooner.
One quick thought. Start small! You are a novice at the buy-to-let game. A good starting point for all new ventures is, "expect no profit and anticipate all possible losses". So, think small -- the biggest oak tree started as an acorn -- and gain practical experience of the property market, of property management; of property finance; of taxes on buy-to-let; of dealing with tenants; of the legal framework of buy-to-let.
Best wishes TTYL

58
Guest Avatar
Gabe 9th September, 2015 @ 15:56

First and foremost HAPPY BIRTHDAY to you!
Not a problem at all Guy and thank you for taking the time to respond.
Already some wise words shared so thanks again.
Best regards and have a great day.
Gabe

59
Guest Avatar
Guy Knapton 16th September, 2015 @ 14:20

Gabe: I'm now able to address your post of September 9th, if it's not too late and of any use. You seem to be asking two questions. First, should I invest in property, and second, how should I judge how much to pay for a property. If they're not your questions, I apologize for reading you wrongly but here goes anyway.
First, over more than a hundred years investments in property have proved to be wise ones, over the long term. Not the most profitable but wise, especially if they provide necessary shelter for us and if they are part of a more diversified portfolio of investments. My personal issue is that the yield from property is overestimated. BBC programmes like Homes under the Hammer, and the introduction to this website, are too often guilty of this mistake. There are two main reasons. Wise investors should never assume annual rental income to be twelve times the monthly rental. Like any business, the buy-to-let one is fraught with problems: voids for want of reliable tenants; the expense of refurbishment and repairs but not betterment; bad debts (tenants doing a runner); and litigation. "Anticipate all possible losses" by assuming, over a long period of say 30 years, an annual rental income of only ten months. If you get twelve months year after year, great and good on you, but don't assume it.
Then, too many people calculate the yield by dividing the 12 months rent by what the property cost them to acquire. No! The denominator has to be the best estimate of what the present market value (net of selling expenses) of the property is. Why? Because if the property were sold, the net proceeds would be available for investment in any one or more alternative investments. We must compare the return on what we have with what it might be if the cash were invested elsewhere.
Investment in property is risky. Take a hard look at the data in this URL http://www.housepricecrash.co.uk/indices-nationwide-national-inflation.php About half the forty years Nationwide have been collecting reliable data, average house prices have been below the trend line. Still -- and this is really important -- on average over 40 years real house prices have risen by 2.9% per year. This means that the real value in 30 years of your £55K invested in the average UK house would be about £130K.
For sterling investors, the least risky investment is Gilts. The UK government has never defaulted on its sovereign debt. Gilts have the name because they were, and still are, deemed to be as good as gold. Today -- and it changes from hour-to-hour -- the yield to maturity of UK 30-year Treasuries is 2.61%. This is by way of a sound benchmark for investing.
Now for the rental yield. Naturally, you want to do better than Gilts, not least to reward you for the greater risk of any other investment, including property however small (please go back to Nationwide's data!). Let's take your two examples. Say you invest £80K in a one-bed to earn £6K/year. In the first year, the rental yield is about 8%. On average, the first year total return would be about 11%. But, unless, you can increase the monthly rent by about 3%/year, the return will fall year by year because the real value of the property is rising at about 3%/year!
You say two beds cost about £200K and the annual rent is, say, £8.5K. That's an annual yield of about 4% in the first year, and a total yield of about 7%. The year by year prospects for the annual return on this investment are similar to those of the lesser one.
From my knowledge, for 100 years the average annual real return on property has been about 8%. Therefore and FWIW, my advice to UK property investors is to assume an average real price increase of 3% and not to accept an average rental yield of less than 5% on the net realisable value of the investment. To maintain the total annual return of 8%, it is therefore essential to increase annual rents by about 3%. This doesn't sound easy, which may partly explain why real property prices seem to fluctuate widely over a 40-year period.
In conclusion, may I say that I'm not a property guru. I don't even live in the UK! I do know just a little (yes, I mean a little) about elementary finance, and by instinct I'm always sceptical of anyone who says or suggests that any investment is a gold mine: in the long run, rewards are proportional to risks. Property may seem to be a gold mine but only to those for whom the inescapable truths of financial analysis are a mystery. For the rest of us, property is a wise, long-term investment as part of a diversified portfolio of carefully chosen investments that suit the circumstances of the person concerned. I wish you all success with your plans.

60
Guest Avatar
matt 21st November, 2015 @ 14:02

yields on residential does not reflect risk (interestingly it does in commercial property)..... targeting yields is a mistake made by 99% of the market...... and its because its simple for agents to understand and for first time investors (but its completely wrong)

Also investing in your local area is again a complete load of tosh

you should buy property that match your investment criteria.... the yield is a by-product of this...as is location

61
Guest Avatar
Guy Knapton 28th November, 2015 @ 08:55

Matt: I would usually refrain from commenting on a post so late, but I cannot let you get away with the points you make, in case others are badly misled by them.
Any investment, including investing in residential property, involves risk and reward. Yield is a measure of the balance between risk and reward.
No one knows what proportion of the market targets yields. Of course, yield should be a target, based, as you imply yourself, on "investment criteria"! Any intelligent investor will compare returns (yields) on alternative uses of the funds available. The alternatives may range from a punt on the 3:30 at Newmarket (risky!) to a significant holding in Gilts (risk-free), and everything in between. Investors target -- choose, that is -- the investments that meet their criteria for risk and reward.
What can possibly be wrong with investing in "your local area"? It depends on our investment criteria, that balance between risk and reward that we all seek but which is different for all of us.
Please steer clear of what are called SWAGs -- scientific wild-ass guesses -- which sound profound but are thoroughly misleading and dangerous.

62
Guest Avatar
Colin 4th January, 2016 @ 10:38

Dear Guy
I never write a post, this is my first!...I wanted to say how I found your nononsense, open thoughts on investment very helpful. After most of a lifetime working hard and with no experience in investing and with no pension to speak of I have recently found myself, following the sale of some property, in the position of needing to invest cash into something that will secure an imminent retirement. I have been looking at BTL property as I have rented property in the past but have had concerns as to the risk and the actual return (yield). Your posts have helped me to look at this more clearly and perhaps consider other options.
Kind regards
Colin

63
Guest Avatar
Guy Knapton 4th January, 2016 @ 14:53

Welcome to posting, Colin, and thank you for kind remarks. I, too, find posting nerve-racking but there are a few subjects that just get me going when I should probably keep my mouth shut.
First, I am absolutely not qualified to give you or anyone else investment advice. I would be wary of anyone who says they are!
Then, I do feel able to say something about risk and reward ("actual return(yield)". As a general rule, reward is proportional to risk. Ask any bookmaker! In property, the best indicator of risk that I know of is Nationwide's data on average real house prices since 1975. Please go here and study it carefully: http://www.housepricecrash.co.uk/indices-nationwide-national-inflation.php
Any idea that property is risk-free is nonsense. On average, average UK house prices rise in real terms about 3%/year, but average house prices fell in just less than half the 40 years of the graph! How do I address this risk? I have a small investment in the shares of one of the UK's largest property companies (let's call it ABC). Over the last five years ABC shares have risen by about 30%, or about 5%/year in real terms: but in 2015 they went absolutely nowhere! The present yield is about 3½%.
It'sometimes said that risk and return are composed of two separate factors: the worrying time and the waiting time. In other words, will the investment pay off at all, and how long will it take for it to pay off? In BTL, it's sufficient that tenants don't pay the rent, trash the property, take you to Court and all those worries, to kill the investment return stone dead. And how long can you wait to get your money back? Property is not a liquid asset: it may be subject to losses and it's not always easy to sell quickly. ABC shares are subject to losses but can be sold in minutes.
With respect to reward, or return/yield, you simply must have a criterion by which to judge your proposed investments. I assume you're a sterling investor -- not a US$ or € investor -- so your best risk-free criterion is the yield on Gilts. No matter what one thinks of the UK government, the Treasury has never defaulted on its debt. The UK yield curve for today is here http://markets.ft.com/research/Markets/Bonds. Study it carefully and often: it changes every minute of every working day. You can see that the risk-free yield is about 2% on 10-year Gilts and about 3% on 30-year Gilts. The 1% difference in yield is mainly waiting time reward.
To compensate for the risk of investing in something other than risk-free Gilts, you must estimate the premium you wish the investment to earn. Only you can answer that question for yourself. From memory and to give you some clues, the long-term (100-year) annual return on property averages at about 8%. Over the last five years the total return on ABC shares has averaged about 9%/year: about 5.5% in share value and about 3.5% in annual dividend yield.
All in all, Colin, I would like to see you fix a BTL premium of 500-600 basis points above the 10-30-year Gilt yield. so somewhere between 7% and 9% per year. On average you can assume a real price increase of about 3%/year -- more in London but less in South Wales -- and a rental yield of between 4% and 6%. If you could do that, you would be doing well but that doesn't mean it's easy. Happy New Year!

64
Guest Avatar
Guy Knapton 4th January, 2016 @ 23:00

Hello Colin:
I drafted a ludicrously long reply to your kind message, but it seems to have gone MIA. No loss, I say, because it repeated most of the points I've tried to make in previous nerve-racking posts. If it does appear, I apologize for appearing to wonk too loudly!
If it doesn't appear, I would like to make one point, again. Deep down, financial analysis is dead simple, the simpler the better. In a separate post, Emma praises the property investment calculator. I'm happy for her if she likes it, but she simply doesn't need all that clever-sounding stuff to know whether she's made a wise investment or not. It confuses simple issues when clear thinking based on reliable data is what's most needed.
You are right to be concerned about the risk/reward ratio of BTL. With many exceptions, the risks are usually underestimated and the rewards overestimated. We hear about BTL investors who crow about their successes but seldom hear from the many who lose their shirts!
Wishing you a happy and prosperous New Year, I must emphasize that I'm not qualified nor authorised to give investment advice. Please be especially wary of anyone who says they are, and never, ever, buy an investment asset from someone who's trying to sell one to you. If it's as good as they claim, why do they want to sell it?

65
Guest Avatar
mr t 5th January, 2016 @ 00:18

I think that Emma's post (and it seems to have gone?) merely suggested a property investment calculator was an aid? Guy is perhaps over-cautious; there are many outlets of investment properties and good ones at that, property brokers market repossessed properties for example and take a commission or finder’s fee, developers sell ‘investment’ properties after completing any refurbishment, the key is due diligence -do your homework, and then do some more. If the numbers stack-up, why shouldn't you buy from someone who’s selling a good investment property?

66
Guest Avatar
Guy Knapton 5th January, 2016 @ 11:11

Morning Mr T:
Yes, something weird took place on this website yesterday. Emma's message is lost and my long reply to Colin went MIA. I fancy you and I are on the same wave length, but I wonder if advising us all to be "wary" is also being "overcautious"?
In the City the joke used to be "never trust a broker trying to sell you a bond"! A nice play on the London SE's motto, at a time when HMG was selling the Consolidated Fund. In property, time share was a huge scam, and probably still is. There are plenty of dodgy estate agents and property brokers, one publicly-quoted London firm that I shouldn't name being a notorious example. Your condition of the "numbers stacking up" is a major condition: too often they don't stack up as well as unwary buyers think.
The risks of buying houses in the UK is best summarised, IMHO, by the jaw-dropping graph here: http://www.bbc.com/sport/cricket/35213969. Over 40 years the average UK house has been a sound investment but nothing spectacular: for owners the 2.9% real increase excludes repairs and maintenance, property taxes, and for landlords letting property can be a nightmare. Property is not a liquid asset: it is subject to losses and can take time to be realised.
It sounds as if you can cope with property's risk/reward ratio. That's great so stick at what you know and enjoy a prosperous 2016!

67
The Landlord Avatar
The Landlord 5th January, 2016 @ 11:35

@Guy
Apologies, your "ludicrously long reply" went into the 'moderation' pile of comments because it contained multiple outgoing links (typical sign of a spam comment) - I have now approved it.

68
Guest Avatar
Guy Knapton 5th January, 2016 @ 13:51

Thank you, Landlord. That's a sensible precaution which I hadn't thought of. Can you resurrect Emma's post, too? If I can have my say, shouldn't she -- and everyone else?
Best wishes for 2016.

69
The Landlord Avatar
The Landlord 5th January, 2016 @ 14:05

@Guy
No probs.

I had a look for a comment by "Emma" but couldn't seem to find it- so I'm not even sure if it existed for this particular blog post (I could be wrong). I looked in the spam/moderation pile of comments.

Best wishes for 2016 too :)

70
Guest Avatar
emma 5th January, 2016 @ 14:12

interesting, i def posted it, erh, I had two people refer to it too, Guy & mr t! oh well, that's technology for you, stick with the property i think!!

71
Guest Avatar
Colin 5th January, 2016 @ 15:21

Hi Guy
Thank you for your response and Happy New Year to you too! I greatly appreciate your candid and straightforward comments and concur with your thoughts on BTL property investment. The way that you have outlined it has clarified my thinking.
In the context of your caveat that you are 'absolutely not qualified to give you or anyone else investment advice' I would be very pleased to hear if you have any thoughts on how to assess the risks involved with investing elsewhere other than BTL property, in particular investing in the likes of BL shares (large established companies) or Schroders fund previously mentioned. I have dabbled in the past; a dalliance with FTSE options (was lucky not to loose my shirt) and some tech stocks in the 90's where I did loose money in the 2000 crash. I appreciate the thinking that investment is best spread along the risk/reward curve but I do not know where to begin in assessing risk with stocks and funds and my pot would need to yield more than the 2-3% that the safe bet government gilts offer. From earlier posts I understand that you 'enjoy the riskiness of the stockmarket' and I am aware that 'fortunes favour the brave' (like you, I am not looking for a fortune, just an income from investment) but for me I think that I am quite risk-adverse and lack the confidence to invest mainly due to lack of knowledge, experience and the feeling that 'I am too far away from the action' to know when a crash is just around the corner.
Kind regards
Colin

72
Guest Avatar
Guy Knapton 6th January, 2016 @ 08:59

Morning Colin:
Thanks so much for your kind remarks on my posts.
Last night I drafted a reply to your recent message. On re-reading it, I decided I couldn't, and shouldn't, send it. I'm really not qualified to give investment advice, especially to someone whose circumstances I don't know. And, I don't live in the UK so there are lots of important things I don't know or master. In my favour, if any, I used to be a teacher -- MBA and all that -- so I may understand something about elementary economic and financial analysis. Like most teachers, my instinct is to help people with the basics and some clear, simple thinking on the subject.
So as not to frustrate you completely, I do have some suggestions. There are a few classics about investing that you may also like. A classic is "The Intelligent Investor" by Ben Graham, the teacher of Warren Buffett as a young man. My copy dates from 1976 so it's not new but still a classic. Another is "Where are the customer's yachts?" by Fred Schwed. It's a hilarious tale of home truths. The internet is full of helpful websites. I like Yahoo Finance: https://uk.finance.yahoo.com/. It's reliable, relatively easy to follow, and has some helpful things. For converting nominal values to real values, go here: https://www.measuringworth.com/ukcompare/. Beware of being fooled by this issue: always think real values! For some help with risk, from time to time consult the VIX index, aka the worry index: http://www.marketwatch.com/investing/index/vix/charts. It's available on Yahoo Finance, too. For good stuff on personal finance, especially for selecting suitable investment vehicles, Morningstar stands out: http://www.morningstar.co.uk/uk/. Lastly, for fun and a great education, please dip into Warren Buffet's letters to his shareholders: http://www.berkshirehathaway.com/letters/letters.html. They are outstanding and amusing, too.
Please don't invest a penny of your pot until you feel confident that you do understand what you're buying and why. This requires, alas, some real work and effort, for "a fool and his money are soon parted". (You know what I really mean by a fool:))
Please forgive my stubbornness. Your message just is a subtle invitation to give investment advice:) I'm not qualified to do so, trust me. If I did give any and you lost your shirt, I could never forgive myself. Please beware of any advice you get: even Warren Buffett, the second richest man in the world, cost his firm, Berkshire Hathaway, $444mn by buying Tesco in 2012 and selling in 2014!! Oops! My broker advised me to buy HMV and hold Glencore. Oh dear! I hope you see why I'm so stubborn. Best wishes!
PS I buy second-hand books: http://www.abebooks.com/.

73
Guest Avatar
Colin 6th January, 2016 @ 11:50

Morning Guy
I think that you did answer my question!.....one needs to read up and become knowledgeable on the stock market if one is to invest in it, experience comes over time but even those with much experience get it wrong sometimes.
Thank you for the suggestions on reading material, that is very helpful and it looks like some of the books may be a fun read. Alas, I think that I may be a little to long in the tooth to become informed, experienced and confident enough to invest.
I must say that I would of loved to have seen your first reply, although I totally understand your reasons for not sending it, it would have been interesting, in light of the experience that you have, to have seen your approach to investing. I might be wrong (and often am!) but I suspect that it might come down to a simple and straightforward strategy or key pointers to look for.
I also appreciate you sage comment on advice which runs in line with my own thinking and brings us full circle because I originally came across this site whilst trying to understand more clearly the financial risks of BTL property and where your posts were most helpful.
Kind regards
Colin

74
Guest Avatar
Guy Knapton 6th January, 2016 @ 12:47

Colin:
Thank you for your understanding despite some disappointment.
I fear I may be even longer in the tooth than you say you are, and you're right that, at my age, I do best what is simple and straightforward. I stress test, to use a modern term, every proposal I hear because one of my few certainties is that we have an irresistible urge to believe what we want to believe rather than what the facts are telling us. For example, I constantly hear that investment in property is gold at the end of the rainbow, which it's no such thing, but it is unquestionably a wise, even essential, component of any sound investment portfolio.
As for my simple approach, cash seems to be a poor investment so I only have available what I may need to cover an emergency or unforeseeable calls for cash. BTL is too much like hard work for too little reward, and property is too illiquid for me when, at my age, I may need cash quickly. I don't understand Gilts and other fixed interest stocks, or gold and currencies and stuff like that. So I'm left with the London SE. My modest portfolio of 21 shares, which consists of the usual suspects and a couple of more daring shares, pays me about 4%/year and its value broadly follows the FTSE 100 index. Over the long term I've done OK and kept my boat afloat. I'm not clever enough to speculate, so I trade seldom and BTH (buy to hold). This year I've lost money since May, as have most equity investors, but I don't care: I have faith in the longer-term future of the UK economy, which I expect to grow over this parliament above expectations.
In general, I use three main financial indicators to evaluate my equity portfolio or a particular share: the price/earnings ratio (P/E), the dividend yield and, for a particular share only, the sustainable growth rate. Lastly, I pray for a little luck without which few of us can succeed in any human endeavour.

75
Guest Avatar
Colin 6th January, 2016 @ 16:27

Hi Guy
Thank you for your openness and the clear explanation of your approach to investing. It is much appreciated and refreshing to hear and receive when there is so much misinformation around (particularly online) and people tend to play their cards close to their chest (particularly when it comes to money!). I agree with you about luck and wish you much!
Best regards
Colin

76
Guest Avatar
Guy Knapton 12th January, 2016 @ 11:02

At the risk of appearing to be an unbearable windbag, may I add a different point from BTL and turn to the issue of what other posters call their "pension pot"?
One potential component of any pension pot is some kind of insurance policy which, at a future date, reaching retirement age, say, pays an annuity. I have such an instrument and had another one that I cashed in. This post is a serious warning to take great, nay scrupulous, care before you choose to invest in any such instrument. The best assumption you can make is that the instrument is much more benefit to the vendor than it ever will be to you.
For eight years I have fought a large insurance company which tried to defraud me in several devious ways. With the help of an expert and recourse to an Ombudsman, I have won my case and the company has finally had to compensate me for its fraud with about £15K, a significant proportion of the capital sum. I'm not alone: I can name a handful of friends who have also been robbed in similar ways.
They can do this in all manner of ways: here are just a few. First, these instruments usually use a complicated suite of calculations to account for contributions and other credits. Then, the terminology used and the terms of the policy are often obscure and can be changed during the life of the instrument, often 20 years or more. They are a classic case of asymmetric knowledge: the vendor understands the instrument much better than the policy holder does. The vendor knows that the policy holder is unlikely to query the instrument until maturity by when he will be too old (or dead) to take the enormous trouble to check that the annuity paid is what is due. I can assure you that doing this is real work, and that even the regulators don't always understand the instruments, and are easily more on the side of the insurance companies than with the policy-holders. Lastly, the instruments are often sold by big, known-name "companies" registered in dodgy places, where controls are weak and legal redress out of practical reach.
As there is little reason why anyone should take any of my advice, for independent, humorous support I would like to quote Fred Schwed, who worked on Wall Street in the 1920s before becoming a writer. In his super book "Where are the Customers' Yachts?" (1960), he tells the apocryphal(?) tale of a visitor being shown round the Street and the Battery, with its many glossy yachts at anchor. "These are the bankers' and brokers' yachts," said the guide. "Where are the customers' yachts?" asked the naive visitor. Just so! We've all been warned:)

77
Guest Avatar
Dom T 30th March, 2016 @ 19:21

Some interesting comments ... as usual, some useful some misleading. Actually, one of the most acurate comments was from kaye (june-15). And I'm surprised he chose to not reply to the subsequent comment! So i will....

Using yield as defined by rent/purchase price is one measure but only one of many to consider. Kaye calls this measure 'asset turnover' and whilst he is technically correct, most people call this the yield. This common definition of yield is not misleading as long as you're clear on what the definition is. Personally, i don't like it because its too generic but its handy as a quick comparison between potential BTL investments (assuming you can predict rents to such accuracy).

Secondly ... kaye defines yield as what i would call Return on Capital Employed (does what it says on the tin). And no, equity is not used as the denominator (as guy assumes in his subsequent comment). ROCE uses Total capital cost (inc stamp duty and legal fees. Both cash equity and mortgage debt) ... however kaye did not mention that the numerator should exclude mortgage interest costs (because the ratio is compared to the weighted average cost of capital .. mainly the mortgage rate if highly geared).

Of course, if you really want to and if its relevant, you could also assess your Return on Equity (net profit, now including the interest cost of debt, divided by your cash outlay). This is kinda like an Earnings Per Share measure. But this measure gets silly when its all debt financed.

Oh, but what i actually wanted to comment was on guy's obsession with benchmarking against alternative investments (like UK gov gilts, bonds etc). Yeah, ok, in theory. However, assuming the investment is mortgaged, then the only investment available is in property (because the lender requires a property to secure the debt against). So there are no alternatives to consider! The alternative is to invest your cash deposit but the quantum £ growth on your 40% deposit is going to be a lot less than the quantum £ growth on your 100% capital invested (capital being equity plus mortgage)

Well, thats what i think. But open to criticism.

Qualifications? Accountancy degree, Chartered Accountant for 15 yrs, 6 yrs in Property Finance for FMCG FTSE100. BTL investor.

78
Guest Avatar
Guy Knapton 31st March, 2016 @ 10:41

Dom: those are pretty impressive qualifications but I'm mystified that they lead you to such misleading conclusions.
In all economic analysis, of course there are alternative uses of resources whether our own or someone else's. Without a yardstick, how may we know how wise our choice of uses for those resources is? All investment analysis is based on the premium required over and above the risk-free rate, to compensate for the risk run by choosing to invest in A and not B. Eugene Fama, the 2013 Nobel Prize winner, and others devoted much of their working lives on this and no one now disputes their findings. Nor are their findings remotely theoretical (whatever that might mean).
You seem also to think that whether an investment includes a mortgage or not makes a difference to the rate of return on the investment. Franco Modigliani and Merton Miller dismissed that widespread belief in 1958, and they won the Prize in 1985. In the case of BTL decisions, the issue is the rate of return on the present realisable market value of a property not on what was paid to acquire and refurbish it.
Market rates of return change with every moment. On Bloomberg websites, we can see them change all day long: every morning in our newspapers. Wise, knowledgeable investors follow market rates for everything -- gilts, bonds, property, stocks and shares, currencies, and even the price of cornflakes -- and they continually evaluate what adjustments they might make to their investment portfolios and expenditure pattern mainly to protect themselves from losses but also to allow for risk.
As for your quantums story, I simply don't follow your point so I can safely dismiss it until you can say what you mean. I have a suspicion you may be misusing the true meaning of quantum, as many people do?
Keep polishing those qualifications. Best wishes, Guykguard

79
Guest Avatar
Dom T 3rd April, 2016 @ 21:35

Guy, apologies for the length of this.

Can't say i disagree with any of that (except my misleading conclusions!!). It’s true that the forecasted Return On Capital Employed (ROCE) ratio of any potential investment should be compared to the risk free rate of return (one part of the wacc), and the ROCE of alternative investments being considered (if investments are mutually exclusive), and the weighted average cost of capital (wacc).

Neither do I disagree with Modigliani & Miller ... the ROCE ratio does not change with the financing or gearing (I did say that the interest cost of debt is excluded from the numerator in calculating the ROCE ratio!). I don't understand what i said that you think contradicts this.

And yep, use the present realisable market value (net of disposal costs of course) for any exit or continue decision of an existing investment (not the historic cost) when calculating that investments ROCE. In my earlier post where I defined the capital employed as the equity plus the mortgage I could have been clearer to say equity includes capital growth (as is normal).

All I was saying was that there are lots of measures to use in appraising a capital investment decision (future investments or existing investments) - yield %, ROCE %, even Return on Equity %(which includes interest costs as a deduction from the numerator) to name a few. But that ROCE is the best of these three. So I'm curious to know what I said that was interpreted contrary to above (or what i said that suggests I've come to wrong conclusions!). Nobody has even mentioned using a Net Present Value (NPV) calculation.

You say "yield is a measure of the balance between risk and reward" - comment #62. Really? How does the yield, using the most common definition of yield being the gross rental income divided by the property value as defined in the original article and the one I believe matt is refering to in comment #61, factor in risk??? Where is 'risk' in this equation?? I agree with matt that a lot of the market use yield for the reasons matt gives, but I couldn't say 99% do (he's just trying to make a point here. Don't take the 99% thing literally!). Yield is rubbish and is only good for making quick rough and ready comparisons of one property against another property.

With regard to quantums (meaning the growth expressed as an absolute £ figure) and theory vs practice. I can best illustrate this using an example ... lets say I've got £40k cash and i can either invest in a bond which returns 5% or i can go out and get a mortgage, and use my £40k as a deposit to buy a property of £240k, but the return is only 3% (lets say net of costs, net of interest costs and including capital growth - just to make it comparible). One might say that the bond is a better investment (5% vs 3%). But when i look at the hard cash profit I've made its £2k vs £7.2k!!! Thats what i mean by considering also the quantums involved. Quantum is latin for 'amount' ... add latin to my qualifications!!!! Maybe 'quantum' was a term local to where I've worked at, but we said quantum to be clear and distinct from when we were talking ratios. Of course, I'd love to invest £240k in the bond at 5% but I can't do that because banks don't lend money for that (theory vs practice!).

I'd like to know what your understanding of 'quantum' is? And what is the incorrect version that you assume most people apply?

Captain Hook understands the difference between theory and practice. He recognised in comment #29 that you can't invest the same amount of capital in halford shares as you can in property (because, generally, no one can get a mortgage to buy shares).

When I was being provocative (deliberately!) by saying you're obsessed with comparing to alternatives I was trying to highlight that its not simple to switch from property to something else (other than property) because invariable the property has a mortgage on it ... so to invest in something else means investing not £240k in something else but only £40k (to use my example). And maybe the ROCE ratio is better with the alternative £40k investment but the absolute £ profit number is not.

Oh, one last thing about those two guys you put in so high esteem – I certainly do agree that the ROCE ratio doesn’t change if financed by mortgage or not. I've not seen you say why this is so just to be clear, it’s because the ROCE ratio is generally compared to your weighted average cost of capital ratio. And any new investment with a ROCE % greater than your wacc % is a worthwhile investment. But your wacc DOES change according to your financing structure – so a really highly geared finance structure will have a high wacc (because debt is more expensive). And the mortgage interest rate will also affect your wacc. If your wacc is high then there will be fewer investments which are worthwhile. So financing is relevant! Put another way . . . if I can only borrow at 10% interest rate (extreme, I know) then there really isn’t going to be any point borrowing to invest because the interest paid will wipe out all the profits (the absolute £ profits!!!)

Hope this helps. I don't know, but it feels like you've got a clear understanding on some of the parts but not seeing the whole picture.

80
Guest Avatar
Guy Knapton 4th April, 2016 @ 10:45

Morning Dom T:
At the risk of irritating other readers of these comments, I choose valour over discretion and reply to your main points above. I find them so misleading, even dangerous to the unsuspecting, that I can't resist setting things to rights. Your points sound so impressive but property investment analysis is so much simpler than you make out. I begin the quotes of your points with YOU; mine with ME.
YOU: All I was saying was that there are lots of measures to use in appraising a capital investment decision (future investments or existing investments) - yield %, ROCE %, even Return on Equity %(which includes interest costs as a deduction from the numerator) to name a few. But that ROCE is the best of these three.
ME: Best? Doesn't it depend on what use you're making of each ratio? ROCE was used in the Dupont analysis but is replaced by Return on Assets (ROA) which is simpler and means the same thing (double-entry bookkeeping, eh?).
YOU: You say "yield is a measure of the balance between risk and reward" - comment #62. Really? How does the yield, using the most common definition of yield being the gross rental income divided by the property value as defined in the original article and the one I believe matt is refering to in comment #61, factor in risk??? Where is 'risk' in this equation??
ME: The risk arises from the difference between the yield of the proposed investment and the risk-free yield. All economics is based on the net margin: all the marginal benefits minus all the marginal costs. That's an equation! Fama and others call the net margin the risk premium. Each investor will judge whether the risk premium of an investment meets the criteria set. Among these criteria will be all the benefits foregone by investing in A and not B.
YOU: With regard to quantums (meaning the growth expressed as an absolute £ figure) and theory vs practice. I can best illustrate this using an example ... lets say I've got £40k cash and i can either invest in a bond which returns 5% or i can go out and get a mortgage, and use my £40k as a deposit to buy a property of £240k, but the return is only 3% (lets say net of costs, net of interest costs and including capital growth - just to make it comparible). One might say that the bond is a better investment (5% vs 3%). But when i look at the hard cash profit I've made its £2k vs £7.2k!!! Thats what i mean by considering also the quantums involved.
ME: Oh dear! That is a serious schoolboy mistake. You are comparing investments of different size: 40K compared with 240K. And, you're applying different yields to each of your examples. To do both to prove what you want to believe and not what the facts are saying is little short of dishonest! In my MBA classes you would have got a failing grade for this! The bond is more profitable, of course, by 200 basis points! In the case of the property example and the 7,200 pound profit, 6,000 or 3% would go to your lender leaving you with 3% or 1,200 quid profit. So much for theory and practice!
A word about investments of different size, which may often be the case in property. There is a method of dealing with this: it's called the profitability index which you can find explained in any decent textbook on financial analysis.
On the question of your bond and property investments, trust Modigliani, please! How an investment is financed makes NO difference to the rate of return, with a few obscure qualifications. I can replace your mortgagor with my aged aunt who is desperate to lend me 200K. I invest the 240K in a bond at 5%: I hand over 10K of the yield to her, and keep the 2K balance. We've both earned 5%: the ROA is 5%. How an investment is financed only makes a difference to how the profits/losses (yield) are shared!
YOU: I'd like to know what your understanding of 'quantum' is? And what is the incorrect version that you assume most people apply?
ME: With pleasure! In Latin "quantum" does not mean "amount", but "how much". For about 100 years quantum has been a term in the study of quantum physics, which deals with stuff like atoms and quarks -- minute particles of matter. Read two greats on this: Richard Feynman and/or Murray Gell-Mann (both Nobel prize winners). If the common cliche "a quantum leap", presumably from the TV series, means anything at all, it means an infinitesimally small physical change that makes a big difference to the state of nature! In practice, the cliche mob use it to mean a big change:( If you meant to say "amount", why not say it and avoid being teased by evil people like me?!
If you really want to pursue our conversation, which I would be happy to do so if it were any help to you, please ask the webmaster for my email address, which I hereby authorise him/her to give you, Dom.

81
Guest Avatar
Dom T 4th April, 2016 @ 11:52

Hmmm. Your focus on theory is starting to make sense (you were an MBA lecturer?!).

I'm not sure I'm getting my points across. Will consider emailing if i think there is anything to be gained

82
Guest Avatar
Guy Knapton 29th April, 2016 @ 10:08

It's amazing, jaw-dropping. I'm banging on again about how exaggerated the profits to be made from property can be and how misleading so much of what is written and said about it actually is. Before explaining briefly why, I repeat: property is a wise investment in a balanced portfolio of assets suitable for an individual investor.
This week, The Economist has published an interesting if worrying leading article about the consequences of the property boom in London. One of the worries is where the boom might lead to. A collapse of property prices may seem unlikely but it's not impossible. It's happened before, and when the tide did go out, we could see who was naked and who wasn't.
A pensioner I have time to dig around for interesting stuff. I came across an article in The Guardian dated 12th April 2016 entitled "Why younger people can't afford a house: money became too cheap" by one Dominic Frisby who is billed as a "financial writer". As the comments column was closed (with 1,116 comments) I could not see whether the following points had already been made, nor post my own. Instead, I posted on The Economist article on London property. Any A level student of Economics or Business who wrote what follows would be given a failing grade. Frisby earns real money by writing what I refer to below:
"A factor contributing significantly to increasing prices of property is frequent and reckless exaggeration by the media of such increases. It gives the unwary a wholly false picture of the profits to be made from buying and selling property.
In a recent article in the Guardian Dominic Frisby, a financial writer, wrote "Between 1997 and 2007... house prices...rose by more than 300%". They did no such thing: they rose by about 133%.
They did no such thing for two reasons. First, Mr Frisby seems not to understand the importance of real prices over nominal ones. For anyone writing about property, or any other asset class, this is reckless. Secondly, he doesn't know how to calculate a percentage increase accurately. For a financial writer, this is a schoolboy error.
Between 1997 and 2007, the percentage increase in the nominal price of the average house in the UK was about 206%. Mr Frisby divided the price for 2007 by the price for 1997, with a result of about 306. But that is not the percentage increase in the price! In real terms, based on the RPI, the percentage increase in the price of the average house in the UK was 133%.
The article was addressed to young people. Reading Frisby's utterly misleading
information, young people risk rushing headlong into the property market or wringing their hands in despair for having missed the boat.
Property is an attractive investment, especially as a means of providing shelter. As part of a portfolio of investments, it offers a good balance between risk and reward.
The main risks of property are liquidity. Despite the spectacular rises of property prices in London, in a downturn property can be hard to sell and prices can fall steeply. From 2010 Q2 to 2013 Q1, real prices of the average UK house fell by 13% and only recovered in 2015 Q3. Over a long period, say 30 years, the average annual yield on property ranges from 6% to 8%, with London likely to be consistently in the higher range.
The media should be careful not to fan the flames of property prices by misleading even reckless information about the true state of such an important influence on human welfare."

83

Please leave a comment...

Nobody

Nobody

Landlord

Landlord

Tenant

Tenant

Agent

Agent

Legal

Legal

Buyer

Buyer

Developer

Developer

Enthusiast

Enthusiast