How To Calculate The Rentability Of A Rental Property?

INTRODUCTION.

Money in the bank today is unproductive. What is more, there are institutions that already charge for having funds on deposit. Especially if they are large sums of money. Investment alternatives are varied. Each of them offers opportunities and risks. If you are reading this article, it is because you are interested in knowing the profitability of a rented property.

In this article you will learn how to calculate the profitability of a rental property.

You can also entrust all these steps to professionals like us.

At Proddigia we guarantee to do it as if it were our own.

WHAT IS THE PROFITABILITY OF A RENTAL PROPERTY?

This is the economic return on a property that we own and that is obtained by renting it out to a third party, who pays us a monthly rent for its use.

Obviously, this profitability can be estimated prior to the investment in the purchase of the property. For this reason, acquiring a property to rent implies a series of initial checks to determine whether the investment is within the profitability margins appropriate to the risk that the investment entails.

In other words, we are investing money in the acquisition of a property that, in addition to having a market revaluation, yields us money on a monthly basis.

The 2 magnitudes that initially have to be taken into account are:

Purchase price of the property we plan to rent.
Rental income that we estimate we will be able to collect.

The profitability initially considered is obtained from a very simple formula:

Rental income/ Price of the house x 100

If the price of the property is 100,000 € and the monthly rent is 825 €, the first thing to do is to multiply the monthly rent by 12 months to obtain the annual rent:

825 € x 12 = 9.900 €
We then divide this annual rent by the purchase price of the property:

9.900 €/ 100.000 € = 0,09

The resulting figure is multiplied by 100 to obtain the yield:

0,09 x 100 = 9 %

This would be the profitability of a gross rental property based on these 2 concepts: purchase price and annual rent.

But this profitability is not real. That is why it is called gross profitability.

It is necessary to take into account other factors to arrive at the net profitability of the investment.

We are talking about other expenses that must be subtracted from the gross profitability.

NET RENTAL INCOME: VARIABLE COSTS TO BE TAKEN INTO ACCOUNT

We can classify all expenditures into three categories:

Investment expenses
+ Fixed costs
+ Maintenance expenses

3.1. INVESTMENT COSTS

These are all those necessary, together with the taxes associated with the purchase of a property, and which are added to the purchase price of the property.

If a property has a purchase price of €100,000, to this purchase price must be added:

Notary fees: As the purchaser, you have to pay the notary fees for the public deed. Approximately between 700 and 800 € for the purchase of a property of up to 100,000 €.
Taxes: if you buy a second-hand property, you will have to pay the Transfer Tax (Impuesto de Transmisiones Patrimoniales, ITP) which is 10% of the sale value of the property. If it is new, the VAT is also 10%.
Registration fees: once the deed has been executed at the Notary, it must be presented to the Land Registry, where fees are incurred for registering the sale and purchase and, if applicable, the mortgage. The amount is around 500-800 € for properties up to 100,000 euros purchase price.
Reforms or updating the state of the property: sometimes the property needs a small or major overhaul to make it habitable. The investment in its repair or renovation will depend on its condition. For this example, we will have an average budget of around 3,000 euros.

Intermediary’s commission: usually the services of a Real Estate Agent are used, who charges a fee for his work of intermediation in the sale and purchase. These fees are free.

All this will give us the total investment cost.

3.2. FIXED COSTS

These are the ones that you will have to pay, whether or not you receive the monthly rent. That is why they are called fixed.

They must be taken into account when the property is left empty while we manage to rent it out again. Or when the tenant defaults on payment, which is a possible risk.

The fixed costs are:

Community of Owners: the ordinary expenses of the property, without taking into account the exceptional charges that may arise for works and other services. These must be provided for, especially if we are investing in properties that are more than 15-20 years old.

IBI: property tax, an annual tax payable to the Town Hall where the property is located. The amount varies depending on the municipality and payment is annual, although it can be paid in instalments.

Insurance for the building of the property: it is usual for the tenant who is going to occupy the property to take out insurance for their own damages and civil liability against third parties for the use of the property. It is important for the owner to have building insurance. In other words, the walls. It is also advisable to have insurance against non-payment of rent.

Minimum consumption services: services such as water, electricity and gas must be maintained, even if the property is empty and there is no use. It is advisable to keep these utilities connected in order to facilitate the tenant’s immediate entry into the property.

Rental administration costs: for convenience, investors in rental properties, especially if they have several, hire the services of an administrator who takes care of everything related to their management (collections, repairs, supplies, insurance, etc.) The cost of this type of service is usually a percentage of the monthly rent received from the rented property.

3.3. MAINTENANCE COSTS

In this section you should consider the costs associated with keeping the home in good condition. In other words, unforeseen events and occasional defects.

Repairs: due to use, homes age and suffer damage. If it is not due to misuse attributable to the tenant, you will have to pay for it. Difficult to calculate as it depends on the type of repair.

Leaks: these will depend on the age of the property, its state of conservation and the maintenance work carried out.

Repair and maintenance costs: when a tenant leaves the property and vacates it, before the next tenant enters, it is highly recommended that the property be repaired and prepared so that the next tenant finds it in good condition. Here we can mention as usual: cleaning costs, repair of kitchen cupboards, doors and a coat of paint on the walls.

HOW IS THE NET PROFITABILITY OF A RENTAL PROPERTY CALCULATED?

Now, considering all that has been said above, the fundamental question is the calculation of the net profitability of the investment made in a rental property.

To do this, we will carry out the following calculations based on all of the above.

We are going to do it with a practical numerical example.

PURCHASE PRICE OF A PROPERTY: €100,000

To this amount we must add:

+ INVESTMENT COSTS (Notary, Taxes, Property Register, Initial reforms, Intermediary commission). Let’s estimate that all this amounts to: 20,000 €

All this will give us the TOTAL INVESTMENT COST: 100,000 € + 20,000 € = 120,000 €

GROSS ANNUAL INCOME: 9,900 € (825 € /month x 12 months)

– FIXED EXPENSES (Community, IBE, Insurance, Consumption and Administration): €1,400.

– MAINTENANCE EXPENSES (repairs and maintenance): 1,000 €

TOTAL EXPENSES: 1,400 + 1,000 = 2,400 €

We are going to know the net or “clean” profitability with the following formula:

(Annual income – expenses) / investment x 100

Continuing with the example from the beginning, with a monthly income of €825, the numbers would be as follows:

Annual income: 9,900 euros

Fixed and maintenance expenses: 2,400 €

TOTAL INVESTMENT: 120,000 € (purchase price + Taxes + Notary + Registry + Initial reforms).

Profitability: (9,900 – 2,400) / 120,000 x 100

( (9.900 € – 2.400 €)/ 120.000 € ) x 100 = 6,25 %

This is the NET RENTAL YIELD OF A HOUSE FOR RENT: 6,25 %

Note that the initially estimated gross profitability, only taking into account the purchase price of the property and the expected annual rent, was 9%.

Therefore, if you have any doubts about where to invest profitably, do not hesitate to Contact | Proddigia and we will advise you.