If you are considering buying property to rent, you probably have a lot of questions swimming around your head. The most important and immediately relevant one is probably: is buying to let a good return on my investment?
Historically, property has been one of the best financial investments that a person can make. Despite the fact that housing returns have been lower than average the past 3 years, mostly due to Brexit uncertainty and the recent COVID-19 epidemic, over long periods of time, property returns have fallen between the 5%-6% mark.
That is slightly lower than the average annual market return (~7.6%) but property investments tend to be more stable and long-lasting than other kinds of investments due to the nature of the good itself.
So if you are thinking of buying a house and renting it out to make some money, then it is as good of a time as ever.
One silver lining to the COVID crisis is that housing prices are at historic lows, so if you have some capital built up, it would not be as expensive to buy a house in the UK as it has been for the majority of the 21st century. Interest rates for loans are also at historic lows too so you can likely find a mortgage deal with a good interest rate nowadays.
Of course, if you already own a home then falling property prices are not really a good sign.
Falling property values means your investment is growing slower and you may not be able to get as much rental income as you would like. Such is the nature of the housing market; property depreciation can be a good thing for those who want to buy and it can be a bad thing for those who want to sell.
So we put together this article to talk about average housing rental yields in the UK. We made sure to break this article down by regions so you can get a more accurate picture of where you should buy a house if you want to get the best rental yields.
What Is the Average Rental Yield in the UK?
For most people, rental yields are the most immediate piece of data to check when shopping around for properties. In 2020, the average rental yield across the entire UK was 3.53%. As you might expect, properties in areas that have a higher cost of living tend to have higher average rental yields, but this is not always the case. In some cases, homes in places with low property values will have very high rental yields.
Given that the average price of a home in the UK is £256,000, an average rental yield of 3.53% tells us that you can expect to make around £9,000 from buying a property to let. Again, this is just an average, back-of-the-envelope calculation, and actual rental income will vary based on expenses and location.
Rental Yields, Capital Growth, and Cash Flow
First, though, let’s talk about how, exactly, properties make people money. The two main ways that properties generate income are through rental yields and capital growth. There is also the idea of cash flow that you need to understand.
Rental yield is self-explanatory and is the amount of money you make via renting the property out to a tenant. Capital growth is a bit trickier and refers to how much the property increases in value over a given time period. We will cover each category more in-depth below.
Rental yield is basically the amount of money you can expect each year from rental payments. It is the measure of how much cash your property generates via rental payments expressed as a percentage of that asset’s fair market value.
Calculating rental yield is pretty simple.
- First, you take the annual rental income and subtract any expenses.
- Next, divide this number by the property’s market value.
- Then multiply the number by one hundred and you have your percentage yield.
((RENTAL INCOME – EXPENSES)/PROPERTY VALUE) X 100 = NET RENTAL YIELD
So for example, say your property costs £600,000 and you expect to charge £3,000 a month (£3,000 x 12/mo = £36,000/yr) for rent. Further, assume that you incur £7,000 in expenses over the year. Here is how you would calculate rental yields.
((£36,000-£7,000)/£600,000) x 100 = 4.83%
So your rental yield would be around 5% for that year.
One of the cool things about investments like property is that they can appreciate in value even if you are not doing anything.
Capital growth (also called real estate appreciation) defines how much the market value of a property increases over time. Real estate appreciation is a function of both market conditions and any repairs/updates made on the property.
There are a couple of relevant points of data to understand here. The first is the fair market value of your home.
The actual market value and fair market value of your property are different. The market value is just whatever price the house is listed at. The fair market value is determined by what is called a comparative market analysis (CMA) that figures out the average price of similar properties in the same market. Fair market value can be different than actual market value because homes can be overvalued or undervalued.
Take the annual growth rate +1 and raise it to the power of how many years you want to hold the property and you have your future expected growth. Next, take the future growth and multiply it by the current fair market value of the property and that will tell you the expected future value.
FUTURE GROWTH = (AVERAGE RATE +1) ^YEARS
FUTURE VALUE = FUTURE GROWTH x FAIR MARKET VALUE
Here is an example with numbers to make things easier to represent. Say your house has a current market value of £200,000. Next, let’s say that the average growth rate is 0.035 (3.5%) and you want to keep the house for 15 years. Here is how this calculation would work out
FUTURE GROWTH = (1+0.035)^15 = 1.511
FUTURE VALUE = 1.511 x £200,000 = £302,200
So, assuming these values, your £200,000 home would be worth about £302,000 in 15 years.
Keep in mind that these equations are just estimations. Actually determining your future value is a bit tricky because the average growth rate changes from time to time.
The last concept you need to understand is cash flow. Cash flow essentially refers to how much money you have leftover from your properties once you calculate all income, expenses, and amounts set aside for future repairs/maintenance.
All other things being equal, you want a property that has a high cash flow. Rental properties are mostly assessed for their potential for generating a high positive cash flow and that is one of the main pieces of data that real estate investors look at when determining whether to buy a property.
Cash flow is important because it’s a good overall sign as to how profitable your investment will be. You can also take that high positive cash flow and reinvest it into more properties, thus exponentially increasing your wealth.
Calculating cash flow is pretty simple. Simply subtract your expenses and cash reserves from your gross rental income.
So if your total rental income each month is £3,000 and your monthly expenses (mortgage, taxes, insurance, repair reserves, etc) is £2,100, then your net cash flow for that month would be £3,000-£2,100 = £900.
Average Rent UK
It helps to contextualize these values on average rent in the UK. The average Brit paid £700 a month in rent across 2019-2020. Expectedly, those living in larger cities like London paid more in rent.
It’s not always the case that lower rental income means there is a low rental yield. In fact, the opposite can be true. Properties in places with low rental prices might have very high rental yields because the property is comparatively less expensive to own/maintain, and the frequency of occupancy is high.
Rental income is a good source of income too because it is immediately available. Unlike stocks, which may generate income that is tougher to get access to (e.g. capital gains), rental income is immediate. Properties themselves are fairly illiquid assets but rental income contributes to a higher cash flow.
Average Rental Yield UK By Region
Here is a breakdown of rental yields by region in the UK:
|City||Avg. Property Value||Avg. Rent per Month||Avg. Rent per Year||Rental Yield|
Going through this list you can immediately pick out some key trends to analyse. Despite its symbol as a large city with historical value, London did not even make the list of the top 15 regions in the UK to buy property. London had a surprisingly low 2.83% rental yield, largely in part because of the very high property values.
Similarly, one can find that regions located in the Northwest have comparatively cheap housing prices with decent rental yields. A large part of this trend can be explained by the general movement from congested cities like London to smaller areas, and the success of several regeneration projects in the area. There is no doubt that the regions surrounding Manchester, Birmingham, and Nottingham are probably the prime real estate locations that will see excellent rental yields, despite their relatively low housing prices, compared to the national average of £256,000.
It is important to realize that a lot of these values are recent and are probably being influenced by the current COVID-19 pandemic. For example, rental prices in capital cities like London and Edinburgh have dramatically lowered as fewer people have been wanting to rent in the city as a result of coronavirus lockdowns. As such, respective rental yields in those areas are much smaller than in smaller outlying regions.
Once you pass Southampton on our list, you start to get into the region of average rental yields. Even though these last 5 entries on our list do not have the soaring high rental yields of Manchester or Portsmouth, they are still fairly high and coupled with relatively low housing and rental prices, especially Bradford, which boasts a good rental yield of nearly 5% with sub-£140,000 property values.
One other thing to keep in mind: These property values and yields are subdivided by region but there is even more fine-grained detail to check out for a buy to let property. Even within a specific region, there might be substantial differences in property values and rental yields in a single region.
As an example, take Liverpool. Based on our research, in 2020, the average housing price in Liverpool was £184,134. However, there are significant differences in property values in different area codes. For example, the average property value in the L4 area is £103,495 while the average property value in L19 was £230,494. As you can see, this is a substantial difference in property values within a single region.
The UK’s property market has, in general, experienced a decent boon during the coronavirus pandemic. However, many experts believe that the average housing market will fall up to 5% next year as the economic recession catches up with the housing market. That means we can expect to see property values fall betwen2%-5% over the next year. Lowered property values are also expected as Britain goes through the last few months before the Brexit transition is completely finished.
Which Region Has the Best Rental Yields?
Overall, the Northwest and Northeast regions had the best rental yields over 2020. Much of this growth is due to the “investor triangle” that has arisen between Sunderland, Durham, and Hartlepool. All three regions boast a very high 7% average rental yield and property values tend to be lower than the national average. Each region marks a great location for a buy to let property.
Which Region Has the Worst Rental Yields?
As you might expect from noting its absence from the above list, London had some of the worst property values and rental yields this past year. If you pay attention to the property market this bit of info probably doesn’t surprise you too much. London has been infamous for its low rental yields for a while now, although it generally boasts excellent property appreciation as housing gets more expensive year after year.
Within London, however, there are some regions that are much better for rental yields. For example, Barking and Dagenham have consistently managed rental yields above 5% over the past year and Newham is currently floating just under 5% for rental yields. Overall, the lowest yield regions in London are the Chelsea and Westminster areas.
What is a Good Rental Yield?
Most experts agree that the best rental yields are between 5%-8% and constitutes a substantial ROI. A good rental yield for a property also depends on the property itself. For instance, we would expect yields from student dwellings to have consistently higher returns because there is a consistently high demand for student housing and student dwellings tend to have lower property values.
So when searching out a property investment, it’s important to get a good idea of the average returns of a specific type of property. For example, there may be a substantive difference between buying a condo in an urban region vs a regular home in an urban region. There can be good reasons for buying a more expensive property investment if it is coupled with generally high rental yields.
How Can I Estimate Expenses?
Expenses are an important factor for landlords to consider because they affect your total rental yield. Expenses include all costs that are part of owning and maintaining a property. The most common kind of expenses landlords have to deal with are:
- Mortgage and closing costs
- Property management fees
- Costs for screening applications/tenants
- Periods of Vacancy
- Taxes, insurance, membership dues
- Legal fees
- Emergency costs
Most of the expenses on this list can be broken down into fixed and variable expenses. Fixed expenses are consistent; things like electricity, gas, water, fees, and insurance payments. Variable expenses can vary depending on conditions, such as repairs, periods of vacancy, and any other kind of irregular expense.
This might sound like a lot of information but it’s fairly straightforward. You can simply add up all your annual expenses and divide by 12 to get a monthly expense figure. It also helps to ask other landlords in the area how they estimate their expenses for a buy to let property investment.
It is also important to keep an accurate table of your expenses because you can report qualified expenses to the HMRC and get a tax break. HMRC has very specific rules on what kinds of expenses you can report so make sure you understand what you can and cannot claim on your annual tax sheet.
Rental Yield vs Capital Growth
It is hard to say which factor is more important and both form a necessary part of acquiring a rent to let property. Investors that focus on capital growth strategies are probably more interested in a long-term investment plan. The classic capital growth investor has a general optimism about the property market and looks for places that have a growing demand. Rental yield investors are conversely looking to make a relatively fast return on their property and focus on their month to month income. Rental return is comparatively fast and immediate.
Property prices, monthly rent prices, costs, void periods, and rental yield all differ from place to place. One of the best places to invest in property in the UK these past few years has been growing cities in the North and north west like Manchester and Liverpool. The potential of these kinds of high rental yield properties is that they can make the house pay for itself and generate a good return. The return on a buy to let investment can cover the costs and can help offset any property price drops.
Renting is still a common form of housing and more people are choosing to rent. Your property portfolio can benefit from a rental investment and increasing the number of rental properties you own can exponentially increase your wealth.
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