What rental yield should you aim for? If you want to join the club of 3 million French people who invest in real estate by buying your first property, this question is for you! Measured by a rate, the profitability of an investment depends on certain parameters of which we will try, in this article, to give you the keys.
Calculating your rental profitability: the basics
Before even thinking about rental yields, it is useful to go back to the marker that is used to evaluate the performance of your investment: the rate of return. This is what allows the investor not to go on an adventure, but to count on a really profitable real estate investment, each time he puts his money in play. Several levels of precision characterize this rate: each one has its utility in the process of choosing a good.
The gross profitability of a real estate investment
No need for a simulator to calculate it. It is based on a simple ratio between the purchase cost of a property and the projected income from that property, in other words, the rent. This rate is calculated over a year, by dividing the purchase price of the property by the total income from a rental investment, all multiplied by 100. We thus obtain a first indicative rate: the gross yield. However, the gross profitability (or gross rental yield) is not, in fact, significant for a decision to buy. It is only used as a first approach to measure the interest of this property or to compare several possibilities between them. Often displayed as an end in itself and not as a simple guide, this ratio is not complete for a decision on a project because it lacks the calculation of the net return, the internal rate of return and the net present value.
The gross rental yield formula
Rental yield = Annual rent / total cost of operation *100
What is the gross profitability?
The average gross profitability in Paris is between 3 and 4%, the high range concerning small properties such as studios. In the provinces, this profitability rises to between 4 and 7%. Nevertheless, in order to aim for a good rental yield, it is preferable to look at higher rates.
Net profitability
One understands by net profitability, the profitability net of charges. That is to say that one includes in the calculation the amount of the loads incumbent on the owner who carries out a rental investment. This amount will include the notary's fees, which can reach up to 7% of the price of the property in the old, as well as other charges such as the charges of joint ownership, the land tax, the expenses of insurances, the interest rates at the level of the loan, and the cost of the possible restoration work. The total of these charges will be added to the price of the property in the calculation of the rate, which will have the effect of reducing it, but will also result in a more realistic estimate.
Net profitability
To have a really precise idea of the rate of return of a property, the tax system is a major element to understand in the calculations. Depending on the tax package and the chosen system, the figures can vary considerably. The net-net profitability consists in integrating the impact of the taxes in the calculation, by deducting the charges of taxes and social deductions from the rental income. It is in general this last one that one had to use to compare with other investments like the livret A.
The calculation of cash flows
It concerns another indicator in the line of sight of all the investors. Based on cash flows, it consists in taking into account each month the final amount remaining to the investor, once all the charges have been paid and the rent pocketed. Cumulated over a year, the calculation of the cash flows gives rise to the calculation of the IRR, or internal rate of return, which will measure the performance of the leverage effect of the real estate loan.
What is the most profitable rental investment?
The most profitable rental investment is the one that best meets the needs of an investor. By taking into account the investor's objectives, budget, risk-taking ability and management preferences, it will be possible to identify the most attractive property, both financially and in terms of its use. Generally speaking, however, it is considered that shared apartments and rental properties are the most profitable investments.
Rental yields vary by city.
It is therefore advisable to compare the average rental yields of different cities in order to determine which ones are the most profitable and where to invest. Yields can range from simple to triple depending on the city!
However, the most important thing is to make sure that the property chosen meets the investor's expectations and objectives.
So what rental yield should you aim for?
When the calculation of the rental profitability of his investment becomes clearer for the investor, the question of which rental yield to aim for remains. There are two keys to answering this question: first, the self-financing of the property, and second, the investor's objectives.
To ensure the self-financing of the property
The basis of a successful investment, whatever the rate of return one expects, is above all not to lose money. A rental investment can, in fact, become a millstone around the neck of an investor's neck, if the loan payments are a burden on the budget and the capital gain on resale is uncertain. For this reason, the yield that one must aim at least is that which ensures the self-financing of the property.
The 70% rule
It is not difficult to ensure the self-financing of a property based on the cash flows it will generate each month. Overall, the outgoing cash flow, which resides in the expenses, must be fully absorbed by the rental income, while leaving a surplus. This means that the costs of repaying the loan, the interest on the loan, and the expenses should never exceed the total rental income for the property. To ensure this, the 70% rule is recommended, i.e. the monthly loan payments should not exceed 70% of the rental income, so that the remaining 30% can cover the operating expenses of the property: condominium work, maintenance costs, etc.
This rule is not always easy to apply, but it has the big advantage of allowing to quickly distinguish if acquiring a property is worth it, or if some adjustments are necessary. A property that generates insufficient cash flow can, in fact, generate a better rental yield if we play on 2 variables, by :
- Reducing the amount of the monthly loan payments: for example, by better negotiating the monthly loan payments, by extending the loan term or by increasing the personal contribution;
- or by increasing rental income through a "high yield" strategy, such as seasonal rental, shared rental or furnished rental under the LMNP regime.
Limits of profitability
Profitability is a bit of a compass for investors, but this should not make us forget that it is not the only criterion that should govern the purchase of a new property. The resale and the objective of capital gain must never be forgotten. Because the money that one earns thanks to a very good rental yield during the period of detention of a property, can very well be lost with a capital loss at the time of a resale. Don't forget that rental income is more heavily taxed than a capital gain. It is strongly advised, therefore, to always consider a rental investment in its entirety. This can be done by choosing properties that are subject to constant revaluation and located in "buoyant" areas. It is therefore better to avoid low-cost housing, which will require concessions on the price in case of resale.
Secondly, we must not forget that in real estate, yield is a function of risk, and that high yields will correspond to high rental risks. In this respect, there are two main types of investors: firstly, those who favour rental yields in order to quickly build up a profitable rental portfolio, making full use of the leverage effect of credit. And there are the others, who like to invest in long-term assets (at least 20 years), and who focus above all on the value of their property.
How to reach the desired rental yield?
Once you have a more precise idea of the cash flow you wish to obtain, it is also advisable to identify the means to be implemented to reach them. This is done by choosing the right property, but also by avoiding some traps.
The basics of a good rental return
The location
It is often repeated, but the location of a property determines, for a good part, the future rental yield of a property. Of course, we always prefer properties located in the city center near all amenities, for which there will always be tenants. The location should also be chosen according to the type of property: either located near universities for student housing, or near a business park if it is intended for young professionals.
Management
Taking care of the rental management yourself, i.e. finding tenants, drawing up leases and receipts and dealing with disputes, takes time. But it also saves on operating costs and optimizes ratios. The same is true for work: being able to do some of it yourself allows you to save on the amount borrowed, thus lowering your monthly loan payments and increasing your rental yield.
The tax system
Any income from a real estate investment is taxed, but real estate taxation offers multiple possibilities to reduce this item by a well studied assembly. Pinel scheme when buying new, land deficit to buy a property to renovate, or LMNP to rent in furnished by defiscalising, there is a little for all tastes. A great diversity of regimes which shows that one cannot be interested in real estate by ignoring the subject. Knowing that the choice of the wrong tax system can make an investment go into the red, never underestimate this chapter in your calculations of return.
Rental strategy
Generating high rates of return often corresponds to a specific type of rental, particularly remunerative, which is called "high yield". Roommate and seasonal rentals are the most well known, with rates easily reaching the double digits.
However, beware of seasonal rentals, around which the public authorities have tightened their grip with increasingly restrictive regulations, and whose rental management is cumbersome and time-consuming.
The traps
Some of them are watching for your profitability and often hide behind a too low purchase price. Is such a property well located? If not, it may be difficult to rent, and therefore exposed to the risk of vacancy, while being difficult to resell.
Is it in good condition? If it is not yet the case, it exposes you to renovation work, to be undertaken before buying the property, so as not to experience a hemorrhage in your cash flow later on.
When rental profitability drops
Being interested in the rental profitability of an investment does not only intervene in the acquisition phase of the property, but can also be done when a property is part of a rental park that one wishes to audit. The interest will then be to keep only the properties having a good profitability. In concrete terms, what should be done?
First of all, keep only the properties that are considered profitable, i.e. those with a rate of return of not less than 1% in Paris or 4% in the provinces.
