Which property investment is better? 13% yield on £50,000 or 10% on £100,000

IIInteger Investments

•27 July 2024

On social media, we see a lot of property sourcers offering +10% yields on low cost properties. Unfortunately, most of these returns are deceiving.

Investing in buy-to-let properties can be a lucrative endeavour, but choosing the right investment requires careful analysis and consideration of various factors and to account for all costs, including time management. In this article, we will compare two hypothetical buy-to-let property investments in the UK to determine which one offers better returns and suits different types of investors. We will examine all associated costs, rental income, repairs, and time management to provide a comprehensive comparison.

For the sake of comparison, we do not including purchasing costs such as stamp duty since they are proportionally similar.

Initial investment

Investment A: £50,000 Property

-Purchase Price:£50,000 and legal costs of £1,200

-Monthly Rent:£550

Investment B: £100,000 Property

-Purchase Price:£100,000 and legal costs of £1,200

-Monthly Rent:£850

Monthly and Annual Costs

Both properties incur ongoing expenses, such as maintenance, insurance, property management fees, and mortgage interest. While some maintenance costs like replacing a window or a boiler may be similar, other expenses can differ based on the property value and rental income.

Investment A:

-Maintenance:£50/month

-Insurance:£20/month

-Property Management:£55/month (10% of rent, although it is harder to find good management at lower price points since the time to manage a £550/m property is the same as the time required for an £850)

-Mortgage Interest:Assuming a 75% LTV mortgage at 5% interest rate

- Loan Amount: £37,500

- Monthly Interest: £156.25

Total Monthly Costs: £281.25

Total Annual Costs: £3,375

Investment B:

-Maintenance:£50/month (similar to Investment A since most costs do not change if you are in a better area)

-Insurance:£20/month (similar to Investment A for simplicity, might be slightly more expensive)

-Property Management:£85/month (10% of rent)

-Mortgage Interest:Assuming a 75% LTV mortgage at 5% interest rate

- Loan Amount: £75,000

- Monthly Interest: £312.50

Total Monthly Costs: £467.50

Total Annual Costs: £5,610

Long-Term Maintenance Costs

Long-term maintenance costs can have a significant impact on the profitability of a property investment. Most ads do not account for those. Especially if you invest in a property with many tenants or large turnover, such as HMOs, your property will incur a lot of damage and wear and tear. These costs include major repairs and replacements such as repainting, replacing boilers, roofs, floors, and fixing bathrooms. Let’s estimate these costs over a 10-year period. Also, although we account for some higher costs for Investments B due to, for example, better material, the cost of a boiler or roof is exactly the same, and in most cases contractors are not much more expensive.

Investment A:

-Repainting:£1,500 every 5 years

-Boiler Replacement:£2,000 every 10 years

-Roof Repairs:£3,000 every 10 years

-Floor Replacement:£1,200 every 10 years

-Bathroom Repairs:£1,000 every 10 years

Total Long-Term Maintenance Costs Over 10 Years: £8,700

Annualized Long-Term Maintenance Costs: £870

Investment B:

-Repainting:£2,000 every 5 years

-Boiler Replacement:£2,000 every 10 years

-Roof Repairs:£4,000 every 10 years

-Floor Replacement:£2,000 every 10 years

-Bathroom Repairs:£1,500 every 10 years

Total Long-Term Maintenance Costs Over 10 Years: £11,500

Annualized Long-Term Maintenance Costs: £1,150

Rental Income and Net Returns

Now, let's calculate the net rental income for each property, taking into account the monthly, annual, and long-term maintenance costs.

Investment A:

-Monthly Rent:£550

-Monthly Costs:£281.25

-Annual Long-Term Maintenance Costs:£870

Net Monthly Income: £268.75

Net Annual Income (after long-term maintenance): £3,225 - £870 = £2,355

Investment B:

-Monthly Rent:£850

-Monthly Costs:£467.50

-Annual Long-Term Maintenance Costs:£1,150

Net Monthly Income: £382.50

Net Annual Income (after long-term maintenance): £4,590 - £1,150 = £3,440

The above points to the first lesson, once to take into account your long-term maintenance costs, your returns decline significantly. This does not take into account other costs such as gas certificates, electrical issues, and other repairs that might occur.

Yield Comparison

Yield is a crucial metric for property investors, reflecting the annual return on investment relative to the property's cost.

Investment A:

-Net Annual Income:£2,355

-Total Initial Investment:£51,200 (purchase price + initial costs)

Yield: 4.60%

Investment B:

-Net Annual Income:£3,440

-Total Initial Investment:£101,200 (purchase price + initial costs)

Yield: 3.40%

The yield points to the second lesson. Although from the initial numbers it looked like Investment A was twice as profitable, once you take into account other costs, the differential is much smaller. In monthly terms, the difference is not significant. If you were to buy two properties like investment A, you would earn approximately £100/m more. However, you would need to find two properties, and pay two times legals which would eat your first year additional earnings.

Time Management and Investor Suitability

Time management and the level of involvement required can significantly vary between the two strategies. In investment A you might need to buy two properties, so the level of time you need to invest is twice as much. In some cases, it might even be more since cheaper areas are cheaper because they are less desirable. In this situation, you might find lower quality tenants that increase your time demands (and damages, unpaid rent) significantly.

Growth

Properties located in more valuable areas often appreciate more significantly over time, both in terms of rental income and property value. Investing in a higher-value area can result in greater long-term returns, as the demand for rental properties in these locations tends to be higher, leading to increased rental rates and property values. This appreciation can significantly boost the overall profitability of your investment.

Conclusion: Which Investment Makes More Sense?

Investment A:

-Lower Purchase Price:Easier for first-time investors or those with limited capital.

-Higher Yield:Better for investors seeking higher returns on a smaller budget.

-Similar Maintenance:Basic repairs like windows, boilers, floors, and bathrooms are likely similar in cost and frequency to Investment B (in some cases might be higher).

Investment B:

-Higher Purchase Price:Suitable for investors with more capital or those seeking larger, more stable investments.

-Higher Net Income:Generates more monthly and annual income despite a lower yield.

-Similar Maintenance:Basic repairs like windows, boilers, floors, and bathrooms are likely similar in cost and frequency to Investment A.

Both investments have their merits, but they cater to different types of investors:

Investment A:Ideal for first-time investors or those with limited capital. It offers a higher yield, making it attractive for those looking for better returns on a smaller budget. The maintenance costs and time required are likely similar to more expensive properties. However, most investors move to the second type of investment once their portfolio grows.
Investment B:Suited for investors with more capital who prefer a higher net income and potentially less frequent maintenance. Despite a lower yield, it offers a more stable and larger income stream, appealing to those seeking a balance between income and time investment. Additionally, properties in more valuable areas, like Investment B, are likely to appreciate more in value and rental income over time, providing greater long-term returns.

Ultimately, the choice depends on your financial situation, investment goals, and willingness to manage the property. By carefully considering these factors, you can select the investment that best aligns with your objectives and resources.