Some developers and agents wildly inflate rental returns on properties they are trying to sell to would-be landlords.
Rental return is sometimes referred to as "the yield". In simple terms, the yield is rental income after running costs, divided by the total invested. The figure is often expressed as a percentage and, ideally, should be more than the cost of the mortgage.
Sound simple? In theory, it is. However, there are many tricks that the property trade uses to inflate the yield figure. One is to be over-optimistic on the rent that can be achieved. So, do your own research.
Developers also tend to quote "gross rents" and "gross yields", which means that they haven't allowed for running costs or periods when the property is empty.
Running costs include interest on all money borrowed, letting-agency fees, ground rent and service charges, insurance, replacement of fixtures and furnishings, general maintenance including annual Corgi gas inspections, advertising, legal expenses, phone calls, travel costs and the cost of your time. Unfortunately, too many novice investors seriously underestimate these costs.
For example, where an agency is doing a complete tenant "find and management" service, its fees can easily swallow up to 15 per cent, plus VAT, of the rent.
Fred Drew, of the website www.geta2ndopinion.co.uk, says: "Things such as insurance premiums, maintenance and repair costs will all be much higher on a property that is let out than on one's own home. Building insurance premiums depend on the size of the property and location, but you should budget for about three per cent of the rent. Also, allow for between two and three per cent of the rent for contents insurance, depending on the level of furnishing."
Gas appliances must, by law, be checked by a Corgi- registered gas engineer, and you should add roughly another £50 each year for each appliance.
Also, if your property is more upmarket, you'll have to pay to advertise in the sort of publications or websites that your intended tenants read.
Wise landlords know to budget for bad times, too. You should make an allowance for legal expenses just in case you are unlucky enough to get bad tenants. It can take at least four months to get rid of bad tenants. As well as lost rent, you'll have court fees and other costs, so budget for about a month's rent per year to cover the cost, just in case.
As well as underestimating running costs, few developers will advise inexperienced landlords to allow for times when their property is not let, the dreaded "void period".
The problem with voids is that not only do you lose rent but your running costs go up, too. With an empty property, you'll have to pay council tax and utility bills. Insurance premiums are higher on empty properties.
Agents and developers also calculate yields on just the basic cost of the property. However, as Marsha Wright of www.locationsuncovered.com points out: "A landlord's investment is much more than the basic cost of the property. It includes all costs associated with a purchase - mortgage fees, survey and legal costs decoration, furnishing, the cost of fixing things before you let, and even the cost of your own money invested in the property from the time you exchange to when your tenants move in."
David Lawrenson's Successful Property Letting - How to Make Money in Buy-to-Let is available now at £9.99
How to calculate true net returns
Suppose you are buying a property for £200,000. A developer may tell you that you could get £12,000 a year in rent, giving a return or yield of 6.0 per cent. So far, so good.
* However, if we allow for a one-month void each year, this reduces the annual rent to only £11,000. Then, if we take off realistic annual running costs (excluding interest payments) of say, 20 per cent of the rent - £2,400 - the "true net rent" comes down to only £8,600.
For a property worth £200,000, you could easily spend another £7,000 on the costs of actually buying it and getting it into a lettable condition, making a total of £207,000.
If we now divide the true net rent of £8,600 by the total cost of £207,000, we get a true net yield of about 4.1 per cent - 1.9 per cent less than what the developer told you. This is less than the current mortgage rate, so if the price of the property doesn't go up you'll be losing money.
Be very sceptical about what anyone tells you about the rents they think a property will let for - especially if they are also selling you the property.
Be realistic about all your costs, both the initial set-up and running costs.
Many people misunderstand or mislead when they talk about returns and yields. Ask questions and do your own sums.Reuse content