- The two methods of calculating the profitability of a rental investment
- Know the risks that could impact the rate of return
Before embarking on a rental investment, ie buying a property for the specific purpose of renting it, you must first learn about profitability. Is this an attractive rental investment? To find out, there are methods of calculation. Discover just two techniques to know and calculate the profitability of a rental investment.
The two methods of calculating the profitability of a rental investment
There are two main techniques for calculating the profitability of a rental investment, explained below:
1- Gross rate of return
Here, we take into account only the gross rents collected as well as the purchase price of the property. Just make the connection between the two to get the percentage:Rate of Return = Annual Rent / Purchase Price
Note that the purchase price includes all the costs inherent in the acquisition such as notary fees, credit costs or compensation of the real estate agency. This rate is the one most commonly offered by sellers. It must be borne in mind, however, that it is not completely in line with reality as it is based solely on rents, not taking into account other expenses.
2- Rate of return net of expenses
The rate of return of a rental investment can be calculated by deducting expenses. The calculation is similar to that of the gross rate of return with the difference that maintenance and management expenses (property taxes, various trustee management fees, insurance, non-recoverable expenses) are taken into account:Rate of return = Annual rent (deducted from maintenance / management expenses) / Purchase price
It should be noted that this rate of return also takes into account any changes of tenants, which may imply a period of vacancy during which no rent is cashed. It is also necessary to take into account the tax advantages obtained for example thanks to the devices like the Robien law or the Pinel law which make it possible to take advantage of tax deductions.
This calculation makes it possible to obtain a profitability that is close to reality, but the result differs according to the investor's tax profile. In addition, the rate obtained changes if the situation of the lessor changes (for example in the event of unemployment, retirement or additional resources).
Know the risks that could impact the rate of return
The profitability calculations previously presented assume that all is well, that the property is regularly occupied and especially that there are no unpaid rents. However, we must take into account the various hazards that may arise and increase expenses (or decrease revenues). In particular, it is possible thatwe do not find a tenant for a long time. Or, unfortunately, we fall on a tenant who does not pay his rent. There is also the recognition of damage or other unforeseen that require major work (change of the boiler, installation of double-glazed windows...)
Finally, it is possible that real estate loses value over time. All of these events can significantly reduce the rate of return on a rental investment.