Understanding rental income and capital growth

Landlord Advice - Guiding you through the letting process

Step 2 - Understanding rental yield and capital growth

Row of houses

There are two ways landlords make money through property letting - capital growth and rental income growth. Let's take a look at these in more detail.

When a property increases in value over time, it is known as 'capital growth'. Capital growth, also known as capital appreciation, has been strong in recent times, but the value of property does go up as well as down, and of course the local conditions surrounding your property have a big effect.

Rental income is what the tenant pays you - hopefully this will grow over time too. In addition to the all important income, you will also need to budget for a number of necessary costs. It's worth highlighting what these costs are so you can budget for them. This is especially important as ultimately you are responsible for these costs whether the property is occupied or not.

Insurance premiums

Premiums for buildings insurance vary by area, type and size of property but allow for between 2 and 3% of the rent. For furnished property allow between another 1 and 4% of the rent depending on the level of furnishing.

Replacing fixtures and fittings

Allow for 10% of the rent each year to replace worn out fixtures, fittings and furnishings. Also, be prepared to re-decorate every few years.

Maintenance

Things break down and need to be maintained over time. You will need to allow a percentage of the rent to cover this. The type, age and condition of the property will obviously have an effect on repairs and maintenance of the property, so this should be taken in to consideration when choosing your property to purchase.

Ground rent and service charges

If the property is leasehold you'll have to pay these charges.

Allow for empty periods

Don't assume the property will always be occupied with a rent paying tenant. Budget for a month each year when the property is empty - 'void periods' in landlord jargon.

Letting agency fee

Fees vary but a good Rightmove agent could get you a higher rent than if you find a tenant privately - remember that they have more market expertise and a greater selection of tenants for you to choose from which will more than make up for their charges.

Of course, your biggest cost is likely to be your mortgage.

Many buy-to-let mortgage lenders will only lend up to 80% of the property value, so you'll need to put in some money yourself - which of course has a cost too!

Once you have deducted all these costs from the rent, you end up with your net expected rental income.

If you divide this into the value of the property, including all the costs associated with buying it, you have the 'true' or 'net rental yield'.

So, if net rental income is £10,000 and the property cost £200,000, the net rental yield is simply £10,000 divided by £200,000 which equals 0.05 or 5%.

Once you do the maths, you may find that the net rental yield figure is less than the cost of your mortgage, leaving you with a shortfall. However, if you have bought well, you should expect the rental income to creep up over time - plus you should see some capital growth too.

In the next sections, we'll look at how to buy a property that will hopefully do both.

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