How to calculate return on real estate investment

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Investing in real estate has been a relatively safe investment for decades. However, the return on real estate investments is particularly attractive now, as prices within the sector are going up a trend. After all, the economic crisis has already been long forgotten. And not only homeowners benefit from this. Also you as an investor can profit from this upward trend. Of course it is wise to know the expected return on real estate investments in advance. But how do you calculate return on real estate investment?

The interesting thing about investing in real estate near you is the engagement. You can, by way of speaking, drive by your investment daily (such as office buildings) or even decide to live (temporarily) in it as a holiday villa or a second home. Your return on real estate investments also has a sentimental aspect in such a case. The return on real estate also gives you personal pleasure. Surely, if any mortgage or loan is paid off for the purchase, your investment always retains its value. It is only necessary to avoid any financial pitfalls.

Calculate your return on real estate investments in advance!

As an investor, you want to know in advance what your investment is going to bring. But often you face a real estate offer with opaque terms. For example, brokers and project developers almost always just talk about the gross return. Those yield percentages look tempting, but a return on real estate investments is much more than a simple calculation of rental income minus the costs incurred. You should also consider the purchase price and notary fees. These costs are relatively easy to determine, but for real rental income it is often less easy.

If you put up a property for rent that regularly remains empty, then this obviously has a negative impact on your return. Think in such cases of student hall of residences (frequently changing residents), a holiday home in a less popular environment or a shop in a location where the traders are facing a heavy time (remember Greece?).

The state of the purchased property is also important. If the property needs short-term renovation which you cannot recover on the tenants, your return reduces considerably. Of course, it often involves older properties which need thoroughly renovation to become attractive as a rental property. Which can have a positive impact on the (lower) acquisition value. When you buy in new, you do not face this problem in the first years.

Read moreHow to Become a Young Real Estate Investor

But also new construction is sometimes difficult to rent out. During the economic crisis, many luxury homes and commercial buildings remained empty. Simply because the desired rental price for candidates was too high. Or because the property was in the wrong neighbourhood. A beautiful villa in a socially less attractive neighbourhood is less desirable than a perfectly identical villa in a beautiful residential environment.

Always check whether your expensive purchase has multiple purposes. If a shop can also become a decent home without significant customisations, then this is certainly an advantage.

Now, how do you calculate return on real estate investement?

Calculating the gross return is fairly easily by dividing the total rental income by the total investment (i.e. including additional costs related to the purchase). Example: 12,000 euro rental yield on a total investment of 200,000 euro makes 6% return (the outcome of the fracture multiply by one hundred for a percentage).

In order to calculate the net return we need to consider multiple variables. One month of vacancy per year (no exception) yields 8% less income. The tax authorities also takes its part of the gross returns either through the real estate income or the tax on your personal income. Furthermore there are costs for maintenance and renovations, insurance costs on behalf of the landlord and possibly also the reimbursement of any loan used for the purchase.

The costs of all these variables need to be deducted from the rental income to calculate the net return. In the above example, an amount of 4,000 euros in costs reduces the rental revenue to 8,000 euros. Therefore the return on real estate investment lowers to 4%. This is still a very decent yield.

Generally, the initial gross return in solid real estate is significantly lower than the return in later years. Thus is due to declining loan costs and increasing inflation and rental revenues.

Winnie Vincken

20 years of experience as strategic consultant, interim manager & entrepreneur in internet companies. Always interested to talk about innovation, disruptive models & investing with a passion for future developments.