Guidance from Russell Anderson, the Mortgages Commercial Director of Paragon Bank

When it comes to assessing the viability of a property investment, the yield is often the metric most frequently referred to, particularly by media commentators. 

We frequently hear the refrain of ‘you can achieve a better return by just putting the money into a savings account’, and some landlords may agree with that given the Government’s recent stance towards the sector!

Certainly at Paragon, we pay close attention to yield performance of both current landlords and new mortgage applications. 

But unless the landlord is buying the property outright with cash, yield alone only tells part of the story and, more often than not, other metrics are equally as important when assessing an investment opportunity.  

Yield does not take into account many factors, such as whether the landlord has borrowing against the property, or the loan to value and rate of that finance. It doesn’t consider any further investment the landlord may make to upgrade the property, or additional purchase costs, such as Stamp Duty. Nor does it reference the capital appreciation prospects of the property. 

For landlords, the return on investment is the key metric and that is usually higher than the yield of the property, particularly if the landlord is purchasing with a mortgage, using their deposit as leverage. 

Take, for example, our own application data, which showed that the average value of a buy-to-let property in the North West of England was £235,175 in October, with a monthly rental income of £1,538. Based on the rental income as a proportion of the property value, that purchase would generate a yield of 7.85%. 

If you analysed the proposition from a return on investment perspective, based on a landlord purchasing via a limited company using a 75% loan-to-value 5% interest-only mortgage, the return on investment rises to 13.66% over the year, including the Stamp Duty.

If you included management and maintenance fees of £250 a month, that delivers a return on investment of 9.41%, still a healthy number and this doesn’t account for any capital appreciation. 

Of course, I recognise that it’s a basic example and some property costs will be higher than others, but the principle of just assessing a property’s investment appeal just based on yield is flawed, and is often misunderstood by those who comment on the sector. 

As a lender, we look at a couple of key areas – LTV and the Income Cover Ratio, which is the rental payment as a proportion of the mortgage payment, often with a margin added to build in some extra protection. 

Both of these metrics have seen significant improvement since the global financial crisis, which reflects lenders’ more prudent approach in the wake of the credit crunch, but also landlords’ improving balance sheets. 

Paragon’s own ICR across our loan book is around 200% and our last published average LTV was 63.5%, with less than 5% of our portfolio at an LTV higher than 80%. 

If we consider that only approximately 40% of rental properties are financed, what does that tell you? On the whole, landlords are in a healthy financial position, with plenty of equity in their properties and rents that are roughly double that of interest payments. Our latest research showed that 87% of landlords are profitable, with a further 9% breaking even.

Of course, not every landlord will be in this position, and some will certainly have seen their margins come under pressure as mortgage rates have risen. 

But the doomsayers of buy-to-let are wrong. Yes, it’s become more challenging with layered legislation and the Renters Rights Bill looming over the sector. And yes, the extra Stamp Duty surcharge is unwelcome.

However, the sector continues to deliver healthy returns for millions of landlords and investors, particularly portfolio landlords who operate as SMEs, remain active purchasers.