If you want to buy a property, it would be nice to know if it is a good or bad investment. But how can we find out and calculate the return on a property, the cash on cash return and gross rental yield? There are some tools that I created that help you to do this. If you want to know more, just read on.
Preface
When I am thinking of buying an apartment or a house, the first thing I do is evaluate the property. For me, it is an investment that should somehow or sometime yield a profit. It doesn’t matter whether I want to rent out the property or live in it myself.
If you want to move into the purchased property yourself, then always ask yourself the following questions. How long will I live in the property? Do I want to rent it out or sell it afterwards? Which makes more economic sense? You must consider your assets as a whole. Do not limit your view only to your financial investments in shares, funds, bonds or similar. A home is also an investment and must be treated accordingly.
Of course, an apartment intended for renting should yield a profit. Therefore, you should always calculate the cash on cash return before buying the property. My calculator can help you with this, even if it is only an initial guide. There is, of course, more to consider should you decide to buy.
Calculate gross rental yield
This simple calculation is sufficient to make an initial economic assessment. With this, you can then decide whether the object is worth it or not. The bottom line is that this should be the first benchmark that should be met. If this bar is not met, then your best bet is to look for a new property.
At the moment, real estate is very expensive in many parts of the country, as prices have risen very sharply in recent years. Take, for example, an apartment in the Los Angeles area that costs $800,000. The rent to be achieved is about $2,500. The gross rental yield is therefore 3.75%. But when is an object interesting and when is it not?
less than 5%
5% to 7%
greater than 7%
As soon as the value is less than 5% you should avoid buying. Between 5 and 7%, the object can be interesting and worth investing a little more time. From a value of 7%, the property is available at a low price.
When you calculate gross rental yield for a property, that’s not nearly enough. There are many other points that are important to look at before buying a property and then renting it out.
Even if the dream of owning a home is still so tempting, you should consider the following. Never spend too much money on an object, no matter how beautiful it is. Even Warren Buffet still lives in a house he bought in 1958.
Calculate cash on cash return
The second indicator is cash on cash return. Here you can calculate the yield based on the money you put in. The calculation actually only makes sense if you want to rent out the property and not stay in it yourself. When owning a home, you try to bring in as much equity as possible. As a result, the cash on cash return will be poor even in the event of future rental.
In contrast, you should use as little capital as possible if you want to rent out. Thus, you can take advantage of the leverage effect. In this effect, the yield on equity is increased through the use of debt capital. The more money you borrow from the bank, the greater the impact on your earnings.
The following cash on cash return calculation is very simple. Possible depreciation’s from the object and also the taxes are not considered. In addition, you could also include your reserves or other costs. Then, of course, the value will be lower. But as a first guideline, this should be sufficient.
less than 10%
10% to 15%
greater than 15%
As already mentioned, this only concerns properties that are to be rented out. As soon as the cash on cash return value is less than 10% you should perhaps look for another property and/or bank. Between 10% to 15% the object and the financing can be interesting and it is already worthwhile. Above a value of 15% you probably make a good deal, if other details also fit.
Conclusion
The yield calculation helps you to get a rough overview of whether a property is good or bad. In addition, it helps you to calculate how high your yield on the property is depending on the equity invested called cash on cash return. But before you decide to buy, you should take a closer look at these points. Do not let yourself be guided by your emotions and trust solid numbers.
As with any type of investment, real estate and rental prices are not spared fluctuations. Even if these fluctuations are not so great, it can happen that real estate prices stagnate or fall. This was the case in Germany, for example, between 1995 and 2010. There the prices have partly even fallen. In the former east of the republic objects have developed negatively in many places. Therefore, please inform well in advance.
If you plan to buying rental property, then you need to consider many things. Where is the property? How will the place develop in the next few years? Is the property near the center or on the outskirts? How is the apartment cut and how big is the apartment. How easy is it to rent the property?
Even if you are thinking about whether to buy or rent, you should calculate the cash on cash return and gross rental yield on investment beforehand. However, do not rely only on this and weigh the pros and cons against each other. The decision may be different for everyone, but try not to let your emotions guide you.
Outlook and alternatives
It is also interesting to see how real estate has performed over the last few years compared to other forms of investment. If you look at the graphs, you will see the following. The
An alternative to buying your own property can be investing in p2p loans, which invest in real estate. Here, the real estate serves as collateral if the creditor should have payment problems. You can invest in a wide variety of projects and thus diversify your investment. The yield is sometimes very high and can help you to build up assets quickly. Another alternative can be REITs.
As you know, the compound interest effect is enormous and helps you build up your assets. You can then either retire earlier or work less. The possibilities are very diverse. It can also be
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This article is not an investment advice, it is only our personal opinion. We report here only on our personal experiences and findings as private investors. Thus, my texts serve solely to impart knowledge and do not constitute an invitation to buy or sell investment products. For further information please refer to the disclaimer.