When you hear about rental investment a word often comes up: profitability. Your friends brag about their “net returns of 4%”, real estate hunters talk to you about projects with a 7% profitability... But ultimately, what does rental profitability really mean? And how do you calculate it?
What is profitability?
Profitability allows you to understand how much a investment returns compared to its cost: it is an indicator that evaluates the financial performance of an investment by calculating its ability to generate income. More concretely, profitability measures the annual gains generated in relation to the invested capital.
Profitability = gains generated / invested capital
In rental real estate, these gains translate into the rental income generated annually, while the invested capital corresponds to the overall acquisition cost of the property.
Rental profitability = rental income / acquisition cost
But be careful, not everyone is talking about the same thing when discussing rental profitability. Depending on the desired level of precision, this calculation can include more or less elements (notary fees, renovation costs, management fees, insurance, rental charges, property tax, taxation...). While some limit themselves to a non-exhaustive version of this ratio, more commonly called
The different returns and their method of calculation
The gross yield
The gross yield is a very simple ratio to calculate that gives you a quick idea of the financial performance of a rental project. This indicator is not very precise, but it can be very useful for filtering projects: if an investment has a gross yield below your yield objectives, it must be excluded. The gross yield is calculated by dividing the annual rents by the price of the property.
Gross yield = monthly rent x 12 / price of the property
Let's take an example: you buy a studio for €143,000 that you will subsequently rent for €610/month.
Gross yield = (610 x 12) / 143,000 = 5.2%
The net yield
In reality, you will never earn 100% of the rents received because numerous fees and charges will reduce your rental income. Similarly, during the acquisition of the property, various additional fees come on top of the price of the property and significantly increase your investment envelope (notary fees, for example, which are about 8% of the property's price and are therefore not negligible).
The net rental yield is a precise and very objective indicator that measures the performance of an investment net of charges and fees, integrating all the intrinsic factors of the project (which will not therefore vary depending on the personal situation of each investor).
This includes:
1) costs related to the acquisition of the property and its entry into the rental market: notary fees, which are about 8% of the sale price for an old property and 2 to 3% of the sale price for a new property, agency fees, which add an average of 5% to the sale price, renovation work
2) charges related to the rental of the property: rental charges, property tax, management fees if you decide to opt for professional management, unforeseen maintenance work.
If your property is in a low-demand rental area, you also need to take into account rental vacancy. However, if you are embarking on an investment, the wisest choice is to select tense areas to ensure that you will find tenants easily.
The net yield is calculated as follows:
Net yield = (monthly rent CC - recoverable charges - non-recoverable charges - property tax prorated - management fees) x 12 / (price of the property + notary fees + agency fees + renovation)
Let's revisit the example above: To buy the property, you paid €11,500 in notary fees and €8,000 in agency fees. The rental charges amount to €40/month and the property tax to €120/year. You decide to delegate the management of your property to a professional agency, which charges you 3% of the rent per month. Your net yield is thus: ((610 - 40 - 120/12 - 3% x 610) x 12) / (143,000 + 11,500 + 8,000) = 4%. By including the charges and fees, we have lost more than 1 point of yield in this case!
The net yield remains the best indicator for comparing rental investments and understanding the financial potential of a project. If you are looking for investment projects, you will notice that many professionals (property hunters or agencies) will talk to you about gross yield or will remain vague about the yield calculation they use. Do not hesitate to inquire: ask them what data they include in their calculation. This will allow you to have a much clearer idea of the interest of the project in question and, on the other hand, to show your interlocutors that you know what you are talking about.
The “real” yield
Net rental income after charges and fees includes elements that depend on the personal situation of each investor: taxes (or tax savings!), insurance, loan costs, etc.
If you want to understand what an investment really brings you (personally), you will need to calculate the “real” yield. To do this, add to the numerator the costs or annual incomes that are specific to you. The most common are the interest on your loan (not everyone borrows the same amount at the same rate and for the same duration), mandatory homeowner insurance, insurance for unpaid rent if you choose to subscribe to it, and taxes or tax savings, which depend on your tax level and the tax regime you choose for your rental.
While the gross yield and net yield are values that can be communicated to you by a real estate professional, you are the only one who can calculate the real yield since it incorporates elements that are specific to your situation.
Also discover
