How to calculate the profitability of a rental investment?

Before embarking on a rental investment, it is crucial to consider several factors. While the location of the property plays a significant role, evaluating the profitability of the investment is just as important. After all, the purpose of investing in real estate is to generate additional income. But what exactly does “rental profitability” mean and how can it be accurately evaluated? Let's get into the details.

Everything you need to know about the profitability of a rental investment

Definition, types of profitability... Here is what it is useful to know about the profitability of a rental investment.

What do we mean by “rental profitability”?

Do you intend to invest in a property that you will then rent out? Your objective is therefore most certainly to receive an additional monthly income. This additional income is what is known as rental profitability.
To define it, here is what we can say: “Rental profitability refers to the relationship between the expenses incurred for the purchase and maintenance of real estate and the resulting rental income.”^[1].
In summary, it is what is left of the monthly amount paid by the tenant after deduction of various charges and others.
You should know that rental profitability is important, but it should not be the only criterion of choice. It is also important to “build a sustainable heritage” and to define various objectives (to rent out as long as possible, to take over the property to live there later, to resell it...).
Regarding rental profitability, did you know that in fact there are three?

Gross profitability, return net of expenses and net profitability

To assess rental profitability, three categories are commonly distinguished: gross profitability, net profitability after deduction of expenses and net profitability after accounting for taxes.

Gross profitability[2]

Gross profitability can be calculated by dividing the annual rent by the price of the property and multiplying the result by 100. This provides a basic insight into the income potential of the property. Here is an example to clarify the calculation: for a home purchased 150,000 euros and rented 650 euros per month, we make 650 x 12/150,000 (= 0.052) x 100 = 5.2. The gross profitability of this home is therefore 5.2%.

Profitability net of expenses

However, to obtain a more accurate assessment, net profitability after deduction of expenses is taken into account. This calculation consists in subtracting property tax, non-recoverable expenses borne by the lessor and management fees from the previous gross profitability. Thus, if for the example used previously, there are 600 euros in property tax, 10% in management fees and 400 euros in non-recoverable expenses, the net profitability of expenses will be 4.01%.

Net profitability

For an overall assessment, net profitability also takes into account taxes levied on rental income, such as social security contributions at an overall rate of 15.5%, as well as income tax on net rental income. This final calculation makes it possible to better understand the real return on investment. While these calculations provide a solid basis for evaluating rental profitability, it is essential to explore methods to improve this aspect of your investment.

How to improve the rental profitability of a property?

By using a mortgage, you have the opportunity to improve the rental profitability of your investment. How? By taking advantage of the “financial and fiscal leverage effect of credit”. Here is an example. If you buy a property worth 100,000 euros that earns you 4,000 euros in annual rent, the gross return will be 4%. By funding “your cash purchase, the net/net return on your investment is 1.74% (with a marginal tax rate of 41% and 15.5% of social security contributions)”.
On the other hand, if you opt for a 3.70% loan (excluding insurance), this will have a positive impact on the profitability of your rental investment, which will thus be greater. For a loan of 50,000 euros and a personal contribution of 50,000 euros, profitability will increase to 1.87% (also taking into account taxable income or even tax due on rents). With a personal contribution of 30,000 euros and a loan worth 70,000 euros, we manage to obtain a profitability of more than 2%.
Borrowing can therefore be a good idea to increase the rental profitability of your property. But it is not the only solution to take advantage of greater additional income. You can also buy a property to renovate.

What is the advantage of leverage in real estate investment?

The advantage of taking advantage of real estate investment lies not only in its profitability, but also in its ability to amplify your returns. By borrowing funds to invest in a property, you can use money from the bank to fund your purchase. Therefore, the rent received from the tenant contributes significantly to the repayment of your loan. This means that a significant portion of your mortgage is being paid off by someone else, increasing your return on investment.

Buying a property to renovate, an idea to remember

Between buying a new property or a property to renovate, is your heart swinging? Be aware that for the same total cost, the second solution may prove to be the best. Indeed, thanks to the purchase of a property to be renovated, you could obtain better rental profitability.
But how is that possible? Simply because the work carried out in a vacant (not occupied) home is deductible from property income. The only condition is that the accommodation is “assigned to housing and intended for rental at the time of work”. Only work that adds value to the property is not deductible.
By buying a property to be renovated, you therefore have the opportunity to benefit from better rental profitability and thus receive an additional monthly income greater than that which you would receive with a new home.

Rental investment advice

[3] Now that you know more about the profitability of a rental investment, it's time for practical advice about investing in itself. Indeed, for it to be a success, it is not enough to find a property, you must also study the city and the region or even assess local taxation.

Take your time and prefer a long-term investment

“Gently, but surely”, this famous adage must be put into practice when buying real estate, whether as part of a rental investment or others.

Take your time!

When you decide to buy a property to rent it out, it is important and even necessary to take your time to think about various elements. It is therefore necessary to ask yourself several questions such as “what type of property to buy? ”, “where to buy it? ”, “how to finance it” or even “what are the conditions for buying a property and renting it out? ”.
The questions to ask yourself are as numerous as they are varied. The ideal is to write them down in order to keep a written record and to be able to find them, later, to ask real estate experts for example.

Seek advice from real estate experts

Indeed, these experts are valuable advisers. Moreover, if we ask for their opinion about the duration of the investment, they recommend the long term rather than the short term. The reason? A short-term investment is of no interest for an individual who will only generate a very low return.
It is therefore highly recommended for individuals wishing to become landlord owners to invest over the long term. This investment will be much more profitable than if it had been made over a short period of time.
In addition, from the sixth year of ownership of a rented property, capital gains begin to be taxed less. From the age of 22, they are even completely exempt.

Study properties and cities/regions well

Before signing the sales agreement, make sure you have carefully studied the property you want to buy. To do this, ask yourself various questions.

Ask yourself if the property is really attractive

If this is an ideal studio for a student, is it located near public transport and schools and other universities? If it is a perfect property for a family, is it also located next to transport, schools, green spaces, car parks and other shops? The environment of the property is important.

What about living space?

Is the area in line with the number of rooms? You don't necessarily think about it, but a 30 square meter apartment with two rooms may be less attractive than an identical surface, but in a T1 version.

Is the property well exposed?

The exposure of the property is also important: ground floor, first floor, facing south, overlooking the street or a private courtyard... For some, these are details that for others are very important.

What are the advantages of real estate?

Details that can be real assets are numerous: equipped kitchen, home automation, renovated accommodation, balcony, terrace, cellar... These little extras can make all the difference and are therefore not to be overlooked.
Concerning the city and the region, again, you have to ask yourself a lot of questions.

What is the economic situation of the city/region?

You like this or that city (or region) and want to buy a property there in order to rent it out. But what do you know about its economic situation?
This is an important question, because a city/region where the unemployment rate is high, where the sectors of activity are not very varied and development projects are rare necessarily attracts less than a city/region where there are jobs and the like.
It is therefore necessary to find out about the economic situation of the city/region where you want to make a rental investment. The site of theINSEE can be very useful in your research.

Properly fix the rent and assess local taxation

Rent is a delicate subject. Landlords want to be able to repay their purchase while renters are looking for the best deal.

Set the rent amount

The rent amount must be carefully thought out. Too high, it could cause tenants to flee and the property could remain unoccupied for a long period of time. However, 12 months without rent means the loss of the benefit of the tax credit. In addition, it means risking a change of regular tenant with the consequence of increasing management costs.
A rent that is too low, on the other hand, will not bring you anything and can even frighten tenants who fear a trap...
The ideal? Set a rent that is in line with those on the market or slightly lower. To do this, find out about the rents charged in the neighborhood and city where the property you bought is located and in particular about those for properties similar to yours. Real estate agency windows and the web will be able to help you. You can also ask the owners and/or tenants directly.

Learn about local taxation

In addition to rent, local taxation is an important point. Who says rental investment, says local taxes (property tax on buildings and non-buildings, tax on the removal of household waste, etc.). Before buying, find out about the rates in the city you are targeting.
What questions should you ask? Is the city in debt? Does it have adapted collective equipment (schools, village hall, etc.)? In what state are the local finances?
Assessing local taxation is essential to know what local taxes would cost you at the time of purchase and for years to come.

Pay attention to condominium fees and relationships with tenants

You have bought a home that you are going to rent out, so here you are a landlord. But beware of condominium fees, which you must monitor closely. To do this:

• participate actively in meetings and others organized between the co-owners. Thus, you will be able to give your opinion on various issues, accept some proposals, refuse others. The idea is not to “incur unwanted expenses.”
• anticipate the rise in charges for you as well as for your tenant.
• listen to the needs and expectations of your tenant (s). Becoming a landlord is not only taking advantage of more or less significant rental profitability, it also means worrying about various questions and problems and of course the comfort of your tenant or tenants.

Would you like to pay monthly rent to an owner who doesn't care about your comments? Probably not. Does your tenant tell you about a problem in the accommodation? Go on site or have a professional intervene to ascertain the nature of the problem. Does your tenant have questions? Be there to give him clear and precise answers. In summary, be present, active, and responsive.

How can return on investment be compared with other investment options?

When comparing return on investment with other investment options, several factors need to be considered. A crucial indicator to monitor is the return on invested capital itself, a measure to assess the financial performance of a project or investment. However, this measure does not take into account the possible financing of the project through a bank loan.

In order to fully understand and compare the financial performance of invested capital, including your own contribution and all monthly savings efforts, it is essential to look at the return on invested capital. This indicator should be compared with the returns of other investment options, such as a savings account or a life insurance policy.

In addition to considering the return on investment, one of the significant advantages of real estate investments, for example, is the leverage effect. By borrowing money for your investment, the bank finances a portion of the property, and the tenant contributes to the repayment of a significant portion of your loan.

Therefore, when comparing return on investment with other investment options, it is crucial to consider not only the potential returns, but also the financing aspect and the additional benefits that certain investments may offer.

How does the method of financing a project impact the profitability calculation?

The method of financing a project has a significant impact on the calculation of profitability. While rental profitability makes it possible to assess the financial performance of a project, it does not take into account the fact that the project can be financed by a bank loan. To truly understand and assess the financial performance of the capital you invest, including your own contribution and any monthly savings made to this end, it is essential to take into account the return on investment. This indicator takes into account the financing method used and provides a more accurate measure of the profitability of the project, reflecting the real returns obtained on invested capital. Therefore, understanding the impact of the financing method on profitability is crucial in order to have a complete assessment of the financial success of your investment.

How does an increase in revenue affect real profitability?

An increase in revenue has a direct impact on real profitability, as it is important to understand that rental rates are linked to the IRL (Rent Reference Index). This means that when revenue increases, rental rates also increase in proportion to the IRL. As a result, higher incomes lead to higher rental income, which translates into an overall improvement in real profitability.

Do you want to make a rental investment in Paris? We offer to help you at each stage of your project. The help of a real estate hunter can be very useful in the search for a property, from visits to procedures through post-purchase. Do not hesitate to contact us for more information.
[1] http://www.financys.fr/lexique.php
[2] https://www.lcl.com/guides-pratiques/immobilier/investissement-locatif/rendement-investissement-locatif.jsp / http://www.pap.fr/argent/investissement-locatif/immobilier-locatif-jusqu-a-7-de-rentabilite/a1263
[3] http://www.linternaute.com/argent/immobilier/reussir-son-investissement-locatif/