The rental return, also called rental profitability or rental ratio is the nerve of the war of any rental investment. Why is this? Because it determines the performance of this investment and also ensures a safety buffer to protect the investor. How is this return calculated, how to promote it and what are the risks: follow the guide and do your accounts!
The rental yield itself
The rental profitability of a property translates into a value that all investors would like to see in 2 figures. Average returns are not as high, but there are types of rentals such as seasonal rental, l'investment property or the flat shareIt can easily exceed 10% or even 15%. So how is it calculated?
To begin with, we take care of a brief calculation, which will be the gross profitability, that is to say the ratio which includes the total of the rents collected over one year divided by the acquisition expenses of the good, the whole multiplied by 100. This brief calculation of rental profitability is only used as an indicator at the beginning, because it is the calculation of the gross profitability which is really used to determine the interest of the investment.
One takes again for this calculation the same ratio, but by including the whole of the expenses related to the acquisition, coming to be subtracted from the receipt of the expected rents. They include in particular :
- Non-recoverable charges on the rental, i.e.: non-occupant owner insurance(PNO), property loan insurance, agency fees, rental management fees, co-ownership charges (trustee fees, electricity for common areas, water....);
- The amount of annual property taxes (which depends on the municipality and the particulars of the housing) ;
- Thetaxation to be expected, depending on the tax system chosen (micro bic, lmp, real system...). Some schemes, such as the deficit foncier, allow not to compromise fiscally a rental profitability. The social levies on rental income, 17, 2% since January 2018, are also to be anticipated at this stage.
- Notary fees.
The calculation of the annual net profitability is then refined by other calculations such as the cash flow, the IRR or the NPV.
- Cash flow refers to all cash flows into and out of an investor's account, considered for an asset.
- The IRR or internal rate of return corresponds to the calculation of the return of an asset over several years, considered from the accumulated cash flow. Its advantage is to allow to compare the interest of several simultaneous financial investments, in order to choose the best one in the long term.
The notions of cash flow and IRR are important to take into account the leverage effect of the loan. The simple calculation of the rental return does not take into account the origin of the funds. On the other hand, the calculation of the annual IRR makes it possible to know how much the investment yields each year, thanks to the real estate loan. Hence the possibility of counting on a purchase resale and a capital gain to reinvest for the experienced investors, thanks to the money of the credit, with an investment in general, without contribution.
An essential calculation
Many real estate investors dream of becoming an annuitant with real estate, but it should not be forgotten that embarking on the adventure involves risks. For this reason, the minimum expected rental return is often self-financing, i.e. to make a purchase whose rental income will cover the loan, interest, taxes and various expenses.
In case of unforeseen events such as a sudden departure of tenants or an unpaid situation, generating a positive cash flow is the best way to face the hard times. In this regard, bankers will always take into account in their simulation, this kind of penalty, in order to better assess the investment capacity of their clients.
For example, in the rental profits of a building of report, it is voluntarily that they will exclude the rental incomes of a rent per month, in their calculation of rental profitability.
It is necessary, indeed, to privilege the reasonable investments and never to sacrifice all its savings nor to go to the maximum of its capacity of indebtedness.
A rental yield must also correspond to investment objectives, defined over the long term. It can be used to build up an estate for one's children, to take advantage of additional income, to prepare for retirement or to tax-exempt one's income.
Locate your investment
The rental performance of a property is closely linked to its location. However, there are some risk-takers in real estate who take advantage of sparsely populated areas to make lucrative investments, but this remains a matter for specialists.
It is in large cities that investors often seem to hope for a good rental return, even if the price per square meter, too often high, does not favor it. But other aspects, around the location, strictly speaking, will condition the success of their investment project. These aspects remain relatively guided by common sense.
The first is to examine the needs of the local population to better gauge rental demand. The proportion of students, retirees or young workers will determine specific rental needs in terms of housing. The local rental market should not be neglected, since the demand for housing depends on the supply and conditions the price of rents, and therefore, the rental profitability of a property.
It is often a good idea to find out what the future holds for the area, to see if a property is likely to increase in value. Are there any other constructions planned in the future? Are there any facilities or infrastructures to be developed?
There are several sources of information that can help you see things more clearly. The first source is local real estate ads, which can give you an idea of the level of rentals. Some investors also test the market by posting a fictitious ad on a real estate website to conduct a sort of demand survey. This practice also makes it possible to better determine the profile of the tenants and to have a more concrete idea of the price level at which it is possible to rent.
The size of the property
Investors then look for a good rental return based on the type of property they are about to buy. Depending on their financial capacity and their debt ratio, they are looking for the right compromise between cost, location and surface area. The size of the property will then allow them to target a clientele and develop a rental strategy.
- With a studio apartment: the rental profitability will be based on the price of the rent, because small surfaces are rented more expensively while allowing to buy a more accessible property at the beginning. A studio apartment offers a good return on investment for small budgets and is easy to rent in student cities or cities inhabited by young professionals. Turnover is high, however, as these populations are more mobile and unstable and only occupy their homes for an average of two years. It is therefore necessary to expect a decrease in real estate yield during rental vacancies. It will also be necessary to plan for maintenance work between each move, which will of course have a cost.
- With a larger surface: The rental profitability is lower than for small surfaces, but these surfaces present less disadvantages on the length. They are usually occupied by families who settle in permanently. They often have more stable incomes and tend to be more respectful of the rented property. Less rental vacancy and repair costs are therefore in perspective: an important point for the profitability of investments.
- The 2 rooms : it is a compromise between the 2 previous cases.
In order to adapt the home to their rental strategy, many owners do not hesitate to undertake transformation work, breaking down partitions and redistributing space. In this case, they enlist the help of professionals such as craftsmen and interior designers. In addition to allowing them to target certain clienteles, these improvements increase the rental profitability of the property through an increase in rent.
Renovation has other advantages: it helps to increase the value of the property with a view to resale, in particular by complying with new energy standards, which all housing acquired under the Pinel program must meet. It also allows for a quicker response to the demand for a property when it is rented out, which will reduce rental vacancies. Experienced investors do not hesitate to consider renovations, focusing on the equipment that attracts the most attention from tenants, i.e. the kitchen and bathroom. The profitability of the rental property is enhanced by the fact that the work carried out on the property will result in lower taxes, thanks to the system of charges and depreciation.
The visit of the property
It is during the visit of a property that a future buyer will have to evaluate the future profitability of the investment. Depending on the property he is targeting, the points to examine will differ. The elevators to be maintained are often financial woes (a detail to be discussed with the co-ownership) and the same goes for large collective boilers. In terms of rental profitability, buildings from the 70's, which are very energy consuming and poorly insulated, also have a bad reputation. It is therefore not useless to visit a property for sale accompanied by specialized craftsmen to identify the critical points, such as
- The condition of the facade and the roofs: these are the most expensive items. For a building or a house, the state of the roof is a detail that real estate agents often forget to mention. You should therefore not hesitate to work with a roofer to evaluate the work and estimate its final impact on the rental profitability. The same goes for the façade and the earthworks, for which you should consult the latest work reports.
- The heating: the change of this equipment is also expensive. This is why, when buying a house, the boiler room must be visited to check the state of the boilers and the presence of separate water heaters. Apart from the cost of changing a water heater, individual equipment will also result in higher consumption. For a gas boiler, it is advisable to ask for the maintenance logs.
- Windows: they may need to be changed, particularly for insulation and energy performance reasons. To promote the rental profitability of the property, we prefer double glazing, which tenants like.
- The electrical installation and the pipes: they must be up to standards, because they engage the criminal responsibility of the owner in case of accident.
- Sanitary facilities: in poor condition, they must be changed. Linked to the hygiene and health of future tenants, they will act as a deterrent during visits if they are dirty or dilapidated.
For condominiums, the last 3 minutes will allow you to identify any events that could affect the rental profitability. It is good to make sure that there is no pharaonic investment project on the horizon. If the trustee talks about redoing the common areas in marble, this can significantly increase the work budget in the future! It is also advisable to make sure that there are no unpaid charges or that the co-ownership regulations do not prohibit certain work such as verandas or terraces. Finally, it is good to take an interest in the atmosphere within the co-ownership, because certain stormy meetings of the syndic are to dissuade from becoming owner!
There are very few financial investments that are risk-free and real estate is no exception. The life of the tenants is not a long quiet river and many events can come to compromise the monthly resources of the rents which they bring. Other unforeseen events such as an increase in taxes or charges or equipment to be changed can compromise the rental profitability calculated at the beginning.
This is the bane of any investor, because they are likely to literally reduce to smoke the beautiful projects of departure. The eviction procedures for bad paying tenants are long and costly and above all, the loss of income literally plummets the rental profitability of the property.
An unpaid rent, for the owner, often represents a monthly credit repayment to be reimbursed, PNO insurance costs, taxes, charges and the housing tax. It is easy to understand why banks do not grant their loans without being careful about the borrower's solidity.
As much to say that the investment in rental real estate is a sector which requires to hold liquidities. Because trouble doesn't always come at the right time! The owners are sometimes forced to face cash flow problems. They can, if they were careful at the beginning to subscribe a contract which allows it, modulate their monthly payments of refunding of loan. Studying the possibility of a loan repurchase, if the credit rates have dropped, is also a possibility to keep the same repayment period while reducing their monthly payments. Other solutions allow to recover cash like changing the loan insurance for a cheaper one, at the anniversary date of the contract.
All opportunities are good to take to reduce the costs related to an investment whose rental profitability is compromised. In almost 50% of cases, unpaid bills are accompanied by deterioration of the property and it is sometimes necessary to take legal action.
The degradation of the property
Unscrupulous tenants do exist and can leave a dwelling in poor condition. The causes can be various: tenants whose personal situation is critical or disputes with the owner. In most cases, the amount of the security deposit will not be enough to cover the entire cost of repairing the property.
In order to calculate the amount of damage and to try to make the indelicate tenant pay, it is recommended to have an inventory of fixtures done by a bailiff. But, here again, the game is not won. The problems of degradation, as well as the problems of unpaid rent, require to have a cash flow to face the fall of the rental profitability of the accommodation.
Less serious than the worries of unpaid bills or major work to be redone, the rental vacancy represents in fact a black beast, as for the rental profitability of a housing. An unoccupied dwelling is a dwelling which does not bring in any more, but which costs! Each day of vacancy represents a loss for the owner. Depending on the notice period, the tenants have from 1 to 3 months to leave the accommodation. During this time, the owner must work to re-rent as quickly as possible. If the owner fails to find the right tenants in time, he may be forced to lower his rent, which will, once again, be detrimental to the rental profitability of his property.
Protecting yourself from rental risks
Different means to avoid unpaid bills are available to owners who want to preserve the profitability of their property.
To avoid unpaid bills, the first step is to choose your tenant carefully. The tenant must have a sufficient income, but also have a solvent guarantor. From experience, landlords know that guarantors who come from the family are the most serious. Friends or colleagues are more relaxed bonds and a good colleague may have lost his or her position at the time of a disaster.
The second measure is to take out an unpaid rent insurance policy, also known as GLI. This is not compulsory, but it can be very important if the repayment of the loan is a problem, in case of unpaid rent. It has some disadvantages, because the reimbursement of the premiums often takes place only in the 3 months following the loss. The subscription of the contract is also sometimes complicated, the owner having to present guarantees of the solvency of his tenant. The contracts differ in fact, according to the income and the personal situation of the latter.
Good to know: an owner obtains more interesting rates by entrusting the management of his property to a professional who will benefit from a group contract.
To protect against other enemies threatening the rental profitability of a property, a GLI can offer different levels of coverage, with guarantees that will also cover the risks of deterioration of the property or rental vacancy.
To avoid deterioration of the property, it is of course more prudent to select tenants carefully. In some situations, however, it is not always possible to avoid "risky" tenants. For example, when it is the municipality that solicits the owner to rent. In this case, there are safeguards, such as requiring that an association that cares for people in difficulty be allowed to sublet the property, so that a guarantee of repair can be included in the contract.
To prevent a property from becoming vacant, there are a few precautions that can help limit this nuisance for rental profitability.
First of all, rent out properties in good condition. Besides the fact that this allows you to benefit from tax breaks by doing work, it also allows you to keep your tenants longer. A poorly maintained building will scare away solvent tenants and may attract more dubious ones. You can then say goodbye to any rental profitability and hope of capital gain on resale.
Renting a little cheaper up front to keep your tenants longer seems to be a good option. It is preferable to avoid as much as possible the turn over to keep a good level of return, especially if each departure is accompanied by weeks of vacations.
Please note: the "rental vacancy" guarantee of the GLI can compensate a landlord in cases where the tenant dies or has left at the drop of a hat. This guarantee, which is sometimes useful, is, in fact, relatively expensive.
The rental performance of a property is therefore far from being a simple starting calculation. It must anticipate all the accidents that will occur in the life of the lessor, in particular repairs, decisions of the co-ownership or the scourges of unpaid rent or rental vacancy. A warning for future investors who should not commit themselves to rental investment without carefully studying their project in advance.