Understanding Buy-to-Let Yields Amid Market Changes

As the cost of running a buy-to-let business rises and house prices fall, landlords will soon reach a point of no return where investment properties are losing money.

Property cheerleaders are trying to rally the market, but many landlords' buy-to-let profits are flatlining.

Although mortgage rates have doubled from three to six per cent in two years and house prices have dropped 10 per cent, property experts like TV’s Location, Location, Location presenter Phil Spencer label buy-to-let as a long-term investment.

Lenders, like Paragon, advocate landlords should hold their faith in the market and ignore doom-mongers while warning mortgage rates are likely to increase.

Phil Spencer explained: “I am making no money on a couple of flats I own and rent close to Central London. Increased service charges and mortgage rates mean I am only breaking even despite putting up rent."

Don’t sell up, says TV’s Phil Spencer

“So why aren’t I selling up? Because I believe the reasons I bought hold true. Yes, it is going to take longer for the area to reach the potential I think it has, but it will get there, and when it does, then I will make a decision about selling.

“I tend not to purchase buy-to-lets with a firm figure in my head of what I want to get from it. But this isn’t necessarily the same for everyone. I go to work to make my money. My buy-to-let portfolio is a long-term investment that I hope makes some money in years to come.”

Meanwhile, London letting agents Benham & Reeves have analysed yields of the average buy-to-let rental.

The conclusion is gross rental yields are climbing, but net rental yields are falling away.

Based on average figures, purchasing a buy-to-let costs £289,824. The rent return is a handsome  £1,276 a month (£15,312 a year), leaving a gross yield of 5.3 per cent.

But gross yield returns are only part of the story.

Net yield costs impact profits

The net yield accounts for the running costs of a rental home - and this is where rising mortgage interest rates and inflation take a bite of the profits.

Furnished properties are impacted the most. In the past year, electric cookers saw the most significant increase - up 12.3 per cent.

Curtains increased by 8.8 per cent; dishwashers climbed 6.7 per cent, an armchair costs 5.7% more than a year ago, with washing machine costs rising 5.2 per cent and wardrobes by 4.8 per cent.

This leaves the net yield at 3.4 per cent and the gap between profit and cost closing.

Benham & Reeves director Marc von Grundherr said: “Gross yields have remained fairly favourable, but the reality of buy-to-let investing is that there are a whole host of additional costs that need to be considered and accounted for, all of which eat further into the profit margins of landlords.

“This is a small detail that the government needs to consider when waging war against the sector and introducing numerous legislative changes designed to dent profitability.

“What’s more, the cost of goods remains considerably higher than they were just a year ago, so even furnishing a property to an acceptable standard can be an expensive endeavour.”

Buy-to-let yields analysed

Source: Benham & Reeve

What is buy-to-let yield?

Yield is the return on investment, usually expressed as a percentage over 12 months.

Calculate gross yield by dividing annual rental income by the property's value. Multiply by 100 to return the percentage.

The net yield formula is similar - work out the total of any costs, take them away from the rental income and divide by the property’s value. Multiply by 100 to return the percentage.