Why you need to ignore Gross Yields
Before you even start investing in properties you might like to work out how much you could expect to earn, and checking out case studies and other people’s experiences is a very good way of doing this.
You will start to come across phrases such as gross yield, net yield and ROI. If you don’t know what these are they can be quite confusing terms. Fortunately they are simple enough to understand once they are explained, so let’s have a look at each of them in turn.
What is a Gross Yield?
This is a percentage figure and you get it by dividing the annual rental income you receive by the price of the property. So if you have a property which is worth £200,000 and the annual rent is £10,000 then you get a gross yield figure of 5%. If the rent was £20,000 a year then the gross yield would be 10%. This shows that the better the return you get in terms of income the higher this figure will be.
Why you should ignore gross yields
Gross yields are the figures you are most likely to see quoted in marketing literature and by property investment companies. You need to ignore this yield as it’s misleading because it fails to account for costs. So you could have a gross yield of 5% but if costs are running at 4% then your real or net return is 1%.
So what yields should we be focusing on?
The best way to measure a property investment return is either by calculating the net yield or even more desirable the ROI (Return on Investment) Let’s look at both.
What is a Net Yield?
If you ask experienced property investors, many will tell you that net yield is a more accurate reflection of your returns than the gross yield. You can work out the net yield by taking into account all the other costs which you are likely to incur in the year. So if we look at that first example again. The property is worth £200,000 and you rake in £10,000 in rent a year. However, your running costs are £1,000. You now need to take this £1,000 off the rental figure before dividing by the property value. In this case the net yield is 4.5%, compared to the gross yield which we earlier worked out at 5%. This clearly shows that calculating net yield gives a much clearer summary of how much you can make from a property than the gross equivalent.
What is a ROI?
ROI, or Return on Investment is the figure used by the most experienced investors and the yield you should be most interested in. It is simply a way of seeing whether the money you will get back from an investment is enough to make the outlay worthwhile. Let’s say that you invest £50,000 in buying a property, doing it up and paying for insurance and all other costs. Your income which comes in each year would be £5,000. This means that your ROI is a very reasonable 10%, as you receive in income a tenth of your original investment each year.
By using these three different types of calculation you can find different ways of working out whether an investment is right for you and how much it could earn you.
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