Yield seems to be one of those words you either instinctively understand or you do not. If you do happen to understand it, you will know immediately what I mean when I say that – it either brings you immediate answers to certain investment questions, or it leaves you baffled even after it’s been explained in simple detail. It often astonishes me that so few landlords and property investors understand the meaning of ‘yield’ and why it is so important. I regularly come across people who have not got the first idea how to use it, how to calculate it or why they should pay any regard to it whatsoever.
‘Yield’ is the income return on an investment. It is usually expressed as a percentage of the investment’s cost to buy or full market value. The chief purpose is to level the playing field between different and varying investments so that accurate comparisons can be made about performance.
For example, if you invest £10,000 in shares and the income (or dividend as it is known) is £500 per year, then your yield is 5%. In the case of property, dividend is replaced by rent, so a property costing £150,000 and generating £750 per calendar month (£9,000 per year) gives a gross yield of 6%. (£9,000 as a percentage of the full market value of £150,000). We can therefore say the property deal produces a better investment return than the shares.
However, there are two issues you need to be aware of. If using yield to compare returns on different types of asset, you need to factor in the additional costs that may apply to those assets. For instance, in the above example, the property pays a gross return of 6%; thus beating the shares. However, in reality your return would be less as you would have to account for things like insurance, repair costs and other expenses that you do not incur with shares. Therefore, it is important to project your costs accurately and to keep a close eye on your actual returns so as to ensure a precise and up-to-date record of how your investments are performing.
The other issue with buying property is that of costs and financing mechanisms. Some of us would pay cash; some would buy using a mortgage (taking different mortgage products which have varying rates and fees). Therefore, we would all get different yields according to our personal circumstances. That is why yield, as a tool for comparison, is always expressed as a return on the cost of purchase and why it is up to each individual landlord to do their own research and decide what level of yield they are happy with.
Yield comparisons is at its most useful when you have to decide between two likely properties for investment. For example, you have a choice between a house costing £144,000 and generating a rental income of £725 per month, and a flat costing £91,000 and generating £429 per month (with Ground Rent and Service Charges of £485 per year). The house generates a gross yield of 6.04% (£725 x 12 = £8,700 as a percentage of £144,000) whilst the flat generates 5.12% (£429 x 12 – £485 = £4,663 as a percentage of £91,000). Therefore, the house is the better investment despite being more expensive to buy.
The moral of the story? Do your homework and crunch the numbers to make sure that all of investments are sure to yield results.