How Much Profit Can You Make From Renting?
Naturally, landlords want to make a return on their rental property investment, but unfortunately it isn’t just as simple as collecting rental payments each month. Especially ringing true for new landlords, knowing how to find the ideal rental opportunity can be difficult, but understanding how much profit you can make from renting will certainly help evaluate if it is a sound investment choice.
Is Owning a Rental Property Profitable?
Whilst for obvious reasons collecting rent from tenants is synonymous with the with how landlords are expected to make their income, but is this the only way owning a rental property can be profitable; in a word, no. Whilst the amount a rent a landlord is able to collect from a rental property is arguably the backbone of their business, (more on this later) for landlords playing the investment game over a longer term, great benefits can be realised through the capital appreciation of the rental property.
But what is capital appreciation? Sometimes referred to as capital growth, this shows how much a rental property has increased in monetary value over a set period of time and the amount you would gain from its sale. In times of record house prices this can be huge incentive for landlords to consider taking their rental to market.
Ideally, landlords will be able to obtain a rental opportunity that allows them to secure both a lucrative rental yield and, when the time comes to liquidate your property, a handsome return through capital growth. Typically, property investors seeking gains over a shorter term will seek to possess properties in highly contested rental areas that allow them to demand a far higher rental fee and therefore larger rental yield.
Rental property investors typically seek higher returns through capital appreciation in an effort to hedge against other investment vehicles they may have, to fund retirement or any number of opportunities that can arise through this typically longer term return once it becomes realised. The reason for this approach akin to the waiting game allows landlords to continue to benefit from their monthly rental income from tenants, but providing the have purchased the right property, see a much larger return upon its sale.
The crucial caveat here is “the right property”, for some landlords, especially those new to the rental game, this can be an elusive find, but it is always worth the extra effort. Landlords that that use capital growth as the driving force behind their rental strategy will typically seek out property that are in up and coming areas that will soon see regeneration and with it exponentially increase the amount they can expect for not only the sale of the property, but the amount they can request tenants pay in rent. This requires complete faith in the market value of the property increasing, seeing landlord pay a larger deposit toward their investment to minimise any mortgage payments they must make.
How Much Profit Should You Make On a Rental Property?
It goes without saying but, knowing how much you will need to charge your tenants in rent each month will go a long way in making your venture as a landlord far more profitable. When trying to work out how much profit you should make on a rental property, rental yield is a crucial component that cannot be overlooked. Similarly to ROI calculations, the rental yield is a phenomenal indicator of the monetary returns a landlord can expect to see over a fixed period in comparison to the amount paid for the rental property.
The rental yield of a property can be simply calculated through taking the amount of rent that you would charge each year for the property, divide this by the amount paid for the building and multiply this figure by 100. However it is important to note that this will only paint part of the picture for landlords, with this calculation only providing them with the gross yield the property could achieve. For a landlord to have a true representation of their income they will need to work out the net rental yield.
This net yield accounts for the expenses a landlord could incur when running the property, deducting costs such as insurance, referencing and letting fees, leaving the rental property owner with the money they would more accurately be left with. The method of calculating the net rental yield as a property remains largely unchanged when compared with the gross yield; however the total costs attributed to the various aspects of management will be deducted from the annual rental figure.
With this in mind, many consider a rental yield of around 7% to be respectable, leaving the landlord with enough room to comfortably address any issues with the consistency of rental payments, meet their obligation to cover mortgage payments, alongside any maintenance work that may arise with the property.
What Is a Good ROI on Rental Property?
Effectively calculating a return on investment, or ROI, for a particular property can be an essential asset for a landlord, allowing them to evaluate if their choice in doing so was a good decision. For first time or accidental landlords it is easy to become blindsided with the excitement of gaining your first tenants, or simply seeing the rental payments coming in each month; but this doesn’t by any means guarantee long term success, or even viability. Knowing the return on investment for a rental property allows the landlord to have a richer understanding of the costs they have incurred establishing the investment, alongside the monetary gains they should expect to see. These returns are typically demonstrated as a percentage of the costs of the investment and are simply calculated through dividing the net profit taken from the rental and dividing this figure by the total cost of the property.
With this being said, whilst this calculation holds true for many investment vehicles, it unfortunately doesn’t hold true when considering the peripheral costs associated with managing a tenancy. It goes without saying, but much to the dismay of seasoned landlords the mounting costs of repairs, maintenance, replacing furnishings and referencing tenants just to name a few, can work to make margins worryingly thin.
This crucial knowledge has a massively practical application, making landlords far more informed prior to purchasing their next rental opportunity. Knowing what the expenses will be for a property and wagering the returns against this is the ideal measure for comparing rentals within a similar area, of course when doing so it is essential to not distinguishing qualities between the properties, such as size, location and available amenities.
When calculating the potential returns that could be enjoyed through letting out a rental property, it is important to note that the calculation doesn’t account for the unfortunate unforeseen circumstance such as extended void periods or lengthy eviction processes. Whilst initiatives such as taking rent in advance or requesting a larger tenancy deposit from the properties residents could work to quell these concerns, it is important to consider these eventualities nonetheless. However, if a landlord is feeling that they would like to be conservative with their estimations for ROI in order to account for these circumstances, they could always fulfil the ROI calculation with only 10 or 11 months’ worth of rental income.
But, what kind of return on investment can a landlord expect? Naturally, as mentioned the figure can be drastically different when accounting for the size, structure and location of the property but the key commonality is that the ROI is positive. Of course if this is not the case then the landlord is investing money into a property that is ultimately, and rather unfortunately, not generating them any money. The figure that individual landlords consider a “good” return on their investment is down to what their intentions are behind the investment, and if the generated revenue will allow them to accomplish these means. With this being said most landlords and property investors will consider a return on investment on a buy to let property of around 5% to be good, as if the income the landlord receives were to dip any lower than this, problems may arise when trying to cover the costs of running a rental.
How Much Should I Charge for Rent?
It is essential to remember when choosing how much you should charge your tenants for rent, that whilst you are ultimately looking to make a good return on your investment, the rental opportunity that you are offering must be attractive to potential occupants. As we all know landlords are far from exempt from the high upfront costs to renting; however it is important to remember that a tenant has multiple deposits and moving costs to consider before it comes to making their initial rental payment. Thankfully assessing competing rental opportunities in the local area may offer an insight in how much you should charge in rent. If there are many similar properties near you that offer identical amenities for a far lower price, you could be deterring many potential renters from your property. However, if rental demand far outstrips the supply of available rentals in your area then as a landlord you will have much more room to move the rental figure to choose to request.
It goes without saying that a key consideration when deciding how much you should charge for rent is location. Naturally, rental opportunities in major cities, close to university campuses or on the outskirts of commuter towns can be lucrative for opportune landlord, but this will vary with the type of occupants that you wish to attract.
The amount a landlord is able to charge tenants are also largely impacted by if the rental opportunity they are offering is furnished or unfurnished. Landlords will have incurred a higher upfront cost with fitting out the property, even with the basics and must consider the fee that comes with regular maintenance and replacing any damage contents inside the rental property; something they can work to offset through an increased rental return. Whilst the choice on whether to let out your rental property in a furnished or unfurnished condition can largely be attributed to the type of tenant that you wish to attract, this is a similarly important consideration when determining a rental fee. Generally speaking, landlords that rent to students can expect to see a lower rental yield as the tenants would be in a less reliable financial position, with many of the tenancy agreements first requiring the implementation of a guarantor. However, when trying to rent to families or even young professionals, the budget of the target demographic will typically be fair higher and therefore more comfortable paying the landlord a higher rent for the right opportunity.
Whilst it is worth noting that this is typically done as a preventative measure or financial safeguard, landlords that allow tenants with pets will typically request a higher amount in rent. Sometimes called “pet rent”, this modest addition to the amount a landlord chooses to charge their tenants can be a welcome contribution when dealing with any damages to the property and its contents at the close of the tenancy period.
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As a landlord you will gain passive monthly rental income from your buy to let and capital appreciation as the years flit past. And it’s exactly this capital appreciation ...
February 12, 2021
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