Firstly, make sure the property isn't over-priced. Work out your offer based on what you think the property is worth, not what it's on the market for. The best place online to check sold prices is https://www.rightmove.co.uk/house-prices.html. Search for recent transactions of similar properties in the same location, if possible.
Using a similar process to that above, check the likely rental income for your chosen property. Again, search online at https://www.rightmove.co.uk/property-to-rent.html for properties that are as close as possible to the one you're interested in.
Using the figures you've worked out in 1 and 2 above, calculate the gross yield. This is the total rent you estimate you'll collect each year divided by your offer/purchase price (or current market value if you already own the property).
Gross Yield = Gross Annual Rent / Offer Price or Current Market Value
For example:
Annual rent: £12,000
Purchase price: £300,000
Gross yield = 4%
This can help you compare potential investment properties against one another. You can even use it to help guide you on the amount you're willing to offer for a property, based on the gross yield you're aiming for, with a bit of reverse engineering. That is:
Offer Price = Gross Annual Rent / Gross Yield
This is the annual profit you estimate will be generated by the property, divided by its purchase price.
Net Yield = (Gross Annual Rent - Costs) / Offer Price or Current Market Value
For example:
Annual rent: £12,000
Annual costs: £3,000
Annual profit = £9,000
Purchase price: £300,000
Net yield = 3%
Costs will include such things as mortgage payments, agent fees, insurance, repairs, voids, service charges and ground rent.
Net yield is a more accurate figure to work with than gross yield, because it takes into account all your costs and tells you how much money you'll end up with. So it's easier to compare a flat, which may have high service charges, with a house, for example.
The big one. This is the annual profit generated by your property, and takes into account your gearing (the size of your mortgage, if you have one).
ROI = (Gross Annual Rent - Costs) / Cash You've Put In
For example:
Annual rent: £12,000
Annual costs: £3,000
Annual profit = £9,000
Purchase price: £300,000
Mortgage used: £225,000 (75% loan-to-value)
Cash invested: £75,000
ROI = 12%
So by gearing your property purchase by a factor of 4 (you've only put 25% of the money into it, and borrowed the remaining 75%) you've increased your return on investment from 3% to 12% (note that this also increases your risk).
ROI is the most useful calculation in our view, as it lets you know what's going to happen with the cash you've put in, taking into account all costs and gearing. It also allows you to compare property with othe types of investments, such as stocks and shares.
