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Why rental yields don’t matter to property investors

25 April 2014

Landlords and buy to let mortgage lenders often bandy the term ‘yield’ about to describe a good investment, but do yields really matter?

The yield is a short name for the accounting term ‘return on investment’ and describes the money generated in return for capital invested.

Yield is expressed as a percentage for the return in a year, with lenders and commentators suggesting 5% or more is at least the return investors should seek.

However, rising house prices are making yields redundant as the more they increase, unless rents rise with them, the lower the yield.

The result is a nonsense calculation that shows a £500,000 home in London generating £15,000 a year rent has a yield of a miserly 3% while a £150,000 home in the North with a £7,800 a year rent comes in with a yield of 5.2%.

So what does that tell anyone?

The important figure is the rental income and borrowing against the home.

Rent cover stress tests the borrowing to make sure the buy to let mortgage is affordable.

Rental income produces cash flow, while capital appreciation as the home value rises is money in the bank for a later day.

Long-standing property investors have already seen the market flip from capital appreciation/static rents to rent growth/static capital appreciation following the credit crisis.

Now, the market looks set to flip again back to capital growth and static rents.

The fact that the hypothetical yield changes is really a matter of indifference and of minor interest to a property investor.

Property traders advertising their properties as coming with a ‘guaranteed yield’ really can’t make such a claim.

Who can say how a property value will change over the next five to 10 years?

As the yield relies on the property value at each year end, quoting the figure is a nonsense aimed at luring the inexperienced.

The reality is yield is a made up historic figure that has no bearing on future investment performance.