It pays to add up the cost and the benefits of buy-to-let

RENTAL yields on buy-to-let properties have held their own over the past three years, despite the economic downturn.

Chris Baguley, director of Auction Finance Limited, says: “According to the Association of Residential Letting Agents (ARLA), the average rental yield on houses in quarter one of 2009 was 5.1 per cent. This has remained constant over the past three years, while rental yields on flats have increased from five per cent to 5.2 per cent.

“The most significant figure, though, is that average rental yields on houses of multiple occupancy (HMOs) has reached an all-time high of 10.7 per cent, especially in cities with large student populations. Of course, this figure can be enhanced even further by buying a property at auction.

“With property prices and interest rates still low and rents projected to increase over the next 12 months, bricks and mortar provide an attractive alternative to poorly performing savings accounts.”

Although property can give a long-term capital gain, most investors also expect it to deliver a regular income.

Mr Baguley has the following advice for would-be property investors to calculate the likely return.

1. Make sure you understand yields. Many financial definitions exist, some confusing. The only one you really need to get your head around is net yield.

This is the annual rental income you expect from a property minus the annual outgoings such as insurance, repairs and agency fees divided by the purchase price. Here’s a simple example to illustrate the point: Annual rental income (12 x £600) = £7,200. Minus annual running costs (£1,200) = £6,000. Divided by purchase price (£100,000) = six per cent net yield

2. Be realistic with your calculations. It is far better to err on the side of caution than overinflate your likely returns. So, don’t forget to take into account things like empty periods. Using a simple spreadsheet, look at the net yield you can expect based on full 12 months occupancy, right down to six months.

3. Benchmark your yields. Yield levels vary regionally and by the type of property. Stay abreast of changes in the market. ARLA and the Essential Information Group (EIG) both produce quarterly statistics which are worth keeping an eye on.

4. Buy at auction. Figures from EIG show that properties bought at auction deliver significantly higher yields (8.52 per cent for terraced houses and 8.54 per cent for flats). This is because the prices of properties up for auction are generally lower than the prices set by agents and because less fees are incurred.

If you’re new to auctions, attend a couple to get a feel for how they work. And remember, if you are tempted by a bargain but haven’t got your funding in place, Auction Finance Limited will be able to help you there and then.

5. Set a sensible rent. Do your research and get a feel for the going rate for similar properties in an area. Remember, over-pricing and under-pricing can be equally damaging to your investment plans. Make sure you set the rent at a sensible level to attract tenants and hit your yield target.

6. Bigger isn’t necessarily better. All the evidence shows that smaller properties deliver higher yields. If you have a budget of £100,000, far better you buy two smaller properties than one big one.

7. Go out of town. Don’t be wooed by the bright city lights. It is often better to buy a property outside the city centre where purchase prices are lower but demand remains high. Again, do your research and know the area you are considering. A couple of streets can make a huge difference to the appeal of a property and the rental you can expect. Take into consideration things like proximity to bus routes and shops.

8. Weigh up the benefits of improvements. Do they make financial sense and do they make the property more desirable?