Rental yield vs capital gain

Even if you’re an existing landlord who has been in the game for some time, you may remain slightly puzzled by the exact definitions of these terms. To assist, we have compiled some top tips outlining all you need to be aware of when it comes to two of the most vital parts of the lettings process. We also analyse whether one should ever be prioritised over the other for better returns.

First up, what is a rental yield? Well, in its simplest form, a yield is the yearly return you can expect to generate on your rental property through the rental income you receive. You need to be aware of certain things when calculating the rental yield, including the sale price or current value of your property and the rent you anticipate to receive for the year.

Once you have these things, you can estimate the potential rental yield on your home in the following way. You take the annual rent of a property, divide it by the home’s value and then multiply by 100.

Here’s an example. Your property is valued at £400,000, and your annual rental income stands at £15,000, so your yield would work out as 3.75%. (£15,000 ÷ £400,000 x 100).

Meanwhile, if your home had a current value of £250,000 and your annual rental income stood at £12,000, your yield would be higher at £4.8%.

Generally speaking, higher yields are generated on more affordable properties, even though rental income is usually less. That’s because the initial outlay is lower and, as a result, yields are less squeezed.

Naturally, the higher the yield your property can achieve, the better your return on investment will be. Consequently, buy-to-let landlords usually use prospective rental yields as a good way of deciding whether or not a particular property is a wise investment.

Findings on this vary, but the consensus is that average rental yields across the UK typically sit between 3%-5%, with Wales and the north of England the best regions for those landlords looking for the highest rental yields.

According to research carried out by Paragon in Q4 2021, Wales had the highest average yields in the UK (6.9%), closely followed by the North East of England (6.8%). Both these areas tend to have a high concentration of more affordable homes with lower buy-in values.

By contrast, yields stood at 4.8% in more expensive central London, although this rose to 5.2% in outer London. In the other regions of the UK, yields ranged between 5.9% and 6.4%.

Landlords also need to understand the difference between gross yield and net yield. The above calculation gives you the gross yield, while if you want to work out your net yield (in other words, the amount of money you actually take home), you’ll need to take away all the expenses associated with letting a property from your annual rental figure before making the calculation.

Such expenses include landlord insurance, maintenance and repair costs and letting agent fees. This article explains more about what a rental yield is and how you can successfully calculate yours.

Sometimes known as capital appreciation or capital growth, landlords also need to factor in capital gain (or capital gains). Essentially, it’s a Ronseal phrase and tells you how much your home will increase in capital value over time. It also sets out how much you could get for your rental property if you ever decide to sell up in the future.

Landlords have paid far more attention to capital gains in the last few decades, with house prices rising to record levels across the UK.

The most important one depends on whether a landlord is looking to invest for the short-term or long-term. If you’re thinking short-term, you will probably want to consider locations guaranteed to deliver strong rental yields. Meanwhile, landlords with a longer-term view may prioritise regions or cities (London and the South East, in the main) where capital gains have historically been excellent, and house prices have steadily risen.

That said, it is perfectly plausible for landlords to secure both strong rental yields and excellent capital gains over time. But, there is no guarantee of this, and you may want to prioritise one over the other.

As a landlord, you also need to factor in that rental yields and capital gains aren’t the be-all and end-all when choosing an investment property. There are other things to consider, too, such as tenant demand, the length of time rental properties stay on the market, and calculating the level of rent you can realistically charge for it to remain in line with local market values.

Location is vitally important as well. Local amenities, access to green space, good local schools, excellent transport links and easy access to town and city centres will make a rental home more appealing to tenants, so should play a part in any investment decision you make.

It is usually the case that rental yields are at their optimum level in popular commuter towns, especially on the outskirts of big cities like London. That’s because homes in these locations are normally more affordable – making buy-in costs cheaper – while tenant demand remains very high. As a result, there is an excellent chance to charge higher rents (albeit still realistic ones) and find reliable, long-term tenants to keep your home in good hands.

If capital gains are your primary focus, you should focus on up-and-coming locations likely to enjoy rapidly increasing prices in the coming years. The added advantage of this is lower buy-in costs before the area becomes really popular. There is always an element of risk here in backing the right horse – some up-and-coming regions end up being more popular than others – but if you get it right, the rewards can be high.

A safer bet would be investing in areas which have seen house prices increase steadily over several years, seemingly unaffected by various external factors.
Of course, it’s impossible to forecast with 100% certainty what will happen to house prices moving forward. But a general rule of thumb is that if an area is experiencing significant regeneration or has/is going to be the beneficiary of a major regeneration project, such as Crossrail or HS2, prices and demand for homes are likely only to go one way.
Where are the best locations for rental yields?

According to the Telegraph’s Buy-to-Let Market Tracker, which uses data from property website Zoopla, Hartlepool – a town on the North East coast – offers the best yields in England (7.9%), with a typical BTL property setting you back £109,000 and a monthly rental income of £474.

Staying in the North East, the paper’s research found that Middlesbrough is the second most profitable location for landlords in England, with yields of 7.8%.

Stoke, Nottingham, Plymouth and Portsmouth are other areas in England which offer attractive rental yields, while in Wales, areas just north of Cardiff offer the best yields to landlords.

The Telegraph found that Blaenau Gwent offers average rental yields of 7.1%, with a monthly rental income of £537.

But Scotland offers the best yields in the UK, concentrated on the outskirts of Glasgow. Investors in East Ayrshire and North Lanarkshire can generate returns of 8.1% on their properties, the Tracker found.