When are real estate worth investment? Condominium as investment

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When is the investment worthwhile?

When is the investment worthwhile?

Foreign real estate is still considered the capital investment. Together with equities they are regarded as tangible assets, which are still among the inflation-protected investments. In addition to an inflation-oriented rental income, the shortage of building land leads to an increase in value in the stock. However, this assumes that the situation is consistent. As real estate agents say: “Three things are crucial to a property: the location, the location and the location.” But why it’s not that easy, we’ll explain on the basis of the rental yield.

The development in the housing market

The development in the housing market

Actually, you would not have to say a word about this topic. The development is catastrophic from the tenant’s point of view. Let’s take a look in the middle of the republic. The Central Real Estate Committee presented its study for the year 2019 for the Rhine-Main area on 20 March 2019 (1). The city on the Main has a vacancy rate of 0.5 percent for rental apartments. The surrounding area offers cheaper alternatives, but with strong fluctuations. Who offers a one-room apartment in Friedrichsdorf in the Taunus, 20 kilometers from Frankfurt, with a floor space of 25 square meters and 370 USD cold rent, can count on over 100 responses.

Our example of the rental housing market in Frankfurt is representative of Berlin, Munich, Stuttgart and other major cities. If you own an existing property, you can look forward to it. If you want to get on the bandwagon, you have an increasing problem finding properties with the corresponding rental yield. Logically, the sale of a well-rented condominium also increases the price per square meter.

Rental yield and purchase price factor

Whether a property is worthwhile as an investment depends in particular on the rental yield and the purchase price factor. Our calculator gives you a good idea of ​​how profitable a real investment would be.

The rental yield – what is it?

The rental yield - what is it?

If you invest in an investment, you want a corresponding return. Only for deposits, the interest rate almost corresponds to the return, as there are no fees on money market accounts or time deposits. Only the final withholding tax must be taken into account. But even with a securities account, there are additional costs that reduce the return, the gross yield. After deduction of the transaction costs and a possible deposit management fee and withholding tax, an amount significantly below the dividend or the price gain remains – the net yield.

The gross rental return

For rented condominiums, although the final withholding tax is eliminated. However, this is replaced by the personal tax rate. Brokers and property developers like to make a simple calculation when calculating the return on a condominium: annual rental income divided by the purchase price multiplied by 100.  The rental yield is ready. You can do it that way, but you should not. For even if the word “gross” is missing before “rental yield”, the result is by no means the realistic yield from a third party rented condominium. In order to clean up the numbers and to determine the real income before taxes, you must already, as our rental calculator shows, start with the purchase.

The net rental return

The net rental return takes into account the incidental acquisition costs, which can amount to almost 15 percent of the purchase price. Neglecting them would be much like calculating the operating costs of a car without gas mileage. After all, the following costs are incurred:

  • Real estate transfer tax up to 6.5 percent
  • Brokerage fees up to 6 percent net
  • Notary and court about 1.5 percent to two percent

Flat rates are not possible, since both the land transfer tax and the brokerage holiday in the amount are country-dependent. Some federal states have chosen the fair way that buyers and sellers bear the brokerage in equal parts.

The fact is, when determining the purchase price, these three items must be included.

What about during the rental phase? Let’s ignore the interest rates for a possible financing. The cold rent is far from the net income for the homeowner. The rent must be adjusted for non-recoverable additional costs. This includes, among other things, the fee for the caretaker as a constant item, the maintenance reserve or the cost of vacant space when not leased.

In addition to the fixed, non-recoverable incidental costs, variable expenses also play a role. The landlord can not transfer the costs for renovations to the building or refurbishment to the tenant. If a costly roof renovation takes place in one year, it is quite possible that the rental yield will be negative this year. This is the case if a special surcharge exceeds the rental income via the maintenance reserve.

Let’s start with the purchase price calculation. If we stay in Frankfurt am Main, we are looking for a condominium with a floor space of 100 square meters. According to the real estate portal Wohnungsboerse.net (2), the average purchase price for this was 5,651.18 USD per square meter at the end of 2018. Incidental acquisition costs including brokerage fees amounted to 78,973 USD. In sum, the acquirer had to pay 645,091 USD.

The gross rental yield

The gross rental yield

Let us now come to the determination of the gross rental income. For an apartment of this size in Frankfurt am Main averaged 14.63 USD per square meter, ie 1.463 USD per month in rent. The annual rental income is 17.556 USD. If only 600 USD per year are deducted from this amount for the non-recoverable costs, the result is sobering.

With the 600 USD, the expenses for the property manager are calculated in this example. The maintenance reserves are not taken into account as these are based on the age of the house. An acquirer must expect the following average annual costs:

  • Up to five years: 3 USD per square meter
  • 11 to 15 years: 7.50 USD per square meter
  • Older houses: 9 USD per square meter

Exact information is given in the minutes of the owners’ meeting.

The net annual rent in relation to the purchase price, the gross rental return, amounts to just 3.10 percent. It gets even sadder when looking at the net rental return. This is a scant 2.63 percent. An investment in equities would have been more lucrative over the years.

Rules of thumb for buying a property as an investment

Rules of thumb for buying a property as an investment

With the help of some rule of thumb, an acquirer can determine if a particular property is worth investing or not. One of these rule of thumb is the purchase price factor. Ideally, the purchase price is not more than 20 times the cold rent. However, this size comes from before the financial crisis, when real estate has not yet become the home base of unsettled investors and prices exploded.

However, there are also regions in Germany where the purchase price factor is less than 20. However, these are investments in the future. Those who can initially live with low rents and have the time to wait for the Ruhrpotts to restructure will, in a few years, have a net rental income that exceeds the target of four percent in relation to the gross purchase price.

Another rule of thumb is the “four-percent size”. Only from a net rental yield of four percent can a property be considered a lucrative investment.

Risk spreading or “clumping”?

Risk spreading or "clumping"?

In our calculation example, over $ 600,000 in purchase price would be set in the sand. It would make more sense in the case to purchase three apartments of 30 square meters or two two-room apartments instead of a 100 square meter apartment. A look at the rental price index of the city of Frankfurt on real estate portals such as Immobilienboerse.de shows that smaller apartments yield significantly higher rental income, but the square meter price is only marginally higher than that of a large apartment. The background is the change in the population structure. The increasing number of single households makes apartments between 50 square meters and 75 square meters extremely attractive, as wrote in 2014 (3). In addition, many senior citizens are pushing back to the cities because of better infrastructure. Just as a securities investor does not invest all his capital in a stock, a real estate investor should also diversify. The risk of vacancy can thus also be better compensated.

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