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The payback period and the level of profitability of an object are closely related criteria that determine the feasibility of purchasing a particular property and its investment attractiveness. The calculation of these indicators allows you to make an informed decision on the acquisition of a building or a separate room in it. The payback of real estate is expressed in the period after which the object will begin to bring net profit to the owner. The article talks about the rules of calculation, key variables.
Why payback is often calculated incorrectly
The commercial premises market has become more attractive for beginner investors: the entry threshold has decreased, and profitability remains quite stable in contrast to the sphere of residential properties. At the same time, not everyone delves into the particulars of estimating the payback period of real estate.
Most investors are confident that it is enough to divide the cost of the premises by the annual amount of rental income. As a result, real indicators strongly differ from the calculation results, and buyers find themselves with a loss-making object in their hands. To obtain more accurate data, it is necessary to take into account the influence of additional variables that adjust the payback of commercial real estate in any city. The optimal value is considered to be net profit in 5-7 years (up to 10).
Discount rate in calculating the payback of real estate
The discount rate is the cost of cash, taking into account inflation, risks in a particular area of investment, the minimum guaranteed return. Buying a rental business will be beneficial only if this indicator is lower than profitability. You can find out the discount rate by summing up the size of the risk-free profitability of a particular object and the most significant risks of the investment idea.
When calculating the payback period of commercial real estate, you yourself determine which factors are most likely to affect profitability. As a risk-free indicator, you can choose:
- interest rates on bank deposits in rubles for up to 1 year in the most reliable financial institutions of the country,
- yield on federal loan bonds, Eurobonds or valuable government securities,
- key rate of the Central Bank.
After that, the coefficient is calculated by the formula 1 / (1 + discount rate) t, in which t is the number of the forecast period for the receipt of finance. Multiplying the discount coefficient by the amount of future income, you will receive the equivalent of the expected profit, which is taken into account when calculating the payback of real estate.
How to calculate the profitability of rental property?
The person who rented the apartment receives monthly income. A simple time-tested scheme. But how much is this investment profitable? Is it not better to put money on a deposit and not get involved with problem tenants, repairs and taxes? To answer this question, you need to know the size of the annual return on investment.
How to count?
Annual return is calculated as the ratio of annual rental income to total investment. It is important to pay attention not to the cost of the apartment, but to the total cost of its acquisition. And this is repair, furniture, decoration, remuneration to realtors.
Therefore, to calculate profitability, you need to know:
- A) the total amount of investments,
- B) the size of the annual lease,
- C) the annual cost of servicing real estate (one-time and monthly).
The amount of annual rent is calculated by multiplying the monthly fee by 12. This is the planned income. At the end of the year, the amount may be different, because you can rent out for a lower rental price than planned or increase, perhaps for some time the apartment will be empty waiting for the residents. Therefore, the profitability can be calculated planned and real at the end of the year.
One-time annual expenses include real estate tax or payment of an intercom system immediately for a year. Monthly maintenance costs are considered only those paid by the owner. Consider the example of an apartment. For example, these are overhaul contributions. If the tenants pay the consumed resources on the counters, and the rest is paid by the owner (housing maintenance, heating, intercom), then they must also be turned on. If tenants fully pay utility bills, then payments are not taken into account. But you can include the costs of minor repairs or the purchase of some furniture or appliances in the apartment.
The calculation of annual profitability is calculated by the formula (B-C) / A * 100%. We get the percentage of return on the property being leased. It is important to note that property value increases are not taken into account here. In order to calculate real profitability, taking into account price increases, you need to know how much the value has changed. This difference must be added to the annual lease, and then carry out the calculation according to the formula. If prices have fallen, then subtract the difference.
Annual interest yield
If we talk about renting out apartments, then the planned yield on average is 10-12% per annum. In reality, taking into account expenses, it can make up 7-8% per annum. Therefore, it cannot be called a highly profitable type of investment, but relatively safe - yes. Regardless of the situation in the economy, you will always have property, the value of which, although fluctuating, is gradually growing steadily. On the other hand, such an investment is extremely illiquid. If money is urgently needed, it will be difficult to sell it quickly, or it will have to be much inferior in price and lose some of the money.
It may happen that the yield is negative. In this case, a loss is ascertained, that is, the income received has not covered the expenses incurred. In this case, it is worth understanding the reason. Perhaps in a month there were large expenses, for example, glazing the balcony, installing plastic windows, replacing pipes, etc. Or maybe it was just a short rental, and it does not cover monthly expenses, in this case, you should think about raising the price .
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How to calculate profitability for housing, garage, cottage, etc.
Many people rent housing, but for some reason few of them can count annual return. But housing for rent is also an investment. The calculation will help you understand whether it is profitable to rent an apartment or choose other investments.
- First you need estimate current market value of your home to understand how much you can sell your property at the moment. You can study the prices in the market, look at Cyan. For example, let an apartment cost 5 million.
- Now you need to count annual rental income. That is, the amount of the monthly rent (without meters) is multiplied by 12. For example, 25 thousand X 12 = 300 thousand. But here you need to understand that the rental price may fall, grow or the apartment for some time can stand without residents. These are the risks.
- Count total annual expenses for real estate:
- income taxes (if you pay),
- property taxes
- communal apartment (often tenants pay only on counters, and you pay the rest of the communal apartment, that is, housing maintenance, heating, intercom),
- average annual depreciation costs (any minor repairs, the crane broke down, equipment, furniture, unexpected expenses, for example, flooded the apartment of neighbors through no fault of tenants).
In our example, let it be like this: a communal apartment except for the counters of 35 thousand per year + property tax of 1000 rubles + depreciation of 8000 rubles per year = 44000 rubles. Imagine that we don’t pay personal income tax yet, but we are already starting to worry and take only cash, because when transferring to cards you can get burned, and the state is beginning to actively deal with this issue.
- Now we subtract the expense from the amount of annual income to get net income. 300 thousand - 44 thousand = 256 thousand rubles.
- We consider profitability: annual net rental income / housing value X 100. That is, 256,000 / 5,000,000 X 100 = 5.12%.
According to my calculations, in Moscow average profitability of apartments no more than 7%rather 4-6%.
Even now, the annual return on deposits is greater and they are insured for up to 1.4 million. If your amount is greater, you can distribute it to different banks. So you do not need to look for good tenants, worry about housing, be responsible for problems before neighbors, worry about what the tax burns, etc.
Also level liquidity in the case of rent is much lower. Selling an apartment is a difficult process, if you suddenly urgently need money.
The cost of an apartment can not only rise in price, but also get cheaper. For example, in recent years in Moscow this is exactly what happened.
In general, consider and decide for yourself whether these 5-6% of problems are worth it.
How to increase the profitability of real estate investments
There are options when real estate can bring a higher percentage than with long-term leases.
Firstly it commercial real estate. About 8-15% per annum. But here you need to understand the issue well and be able to choose.
Is there some more apartment buildings and apartment hotels. The return on these investments is also usually higher than the return on renting apartments. Management and maintenance is carried out by the Criminal Code. But here, the good location and honesty of the Criminal Code are important. And the entry threshold is higher here.
Third option: you can buy a large apartment, divide it into rooms and rent as a hostel.
Or rent an apartment for shooting (cinema, photo shoots), having spent on the appropriate repair and decoration of the zones.
But the easiest option is just try to rent an apartment . So profitability will be 2-3 times higher. But it takes time to do this. That is, this is no longer a passive investment, but rather a business that requires time, effort, investment and professionalism.
You can rent it through Airbnb to tourists. There is also a booking, but there the commissions are much higher.
There are no restrictions on registering with Airbnb. For placement you need text about the apartment and photos. For starters, you can take photos on the phone, but then it is advisable to call a photographer from Airbnb. It's free, the pictures are likely to be better and so your account will be confirmed after verification on the site. For verification, you will need to confirm social networks and show a passport.
Some write text in English or other languages specifically so as not to accept Russian tourists, but only foreigners.
Service will take commission 3% from the amount of rent you set. And you rent the apartment officially, so you will pay income tax. But even with this in mind, the yield is higher. And from above you can earn on the recommendations of excursions for a percentage. Some guests tip.
Count and try!
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Rental rate indexation
Any lease agreement for a room involves a clause on indexation of fees, which is associated with inflation. The frequency of the cost revision is indicated in the contract, but is usually carried out no more than once a year. A variety of indicators are used as a guide:
- fixed percentage
- inflation rate
- government-set rates or odds,
- several fixed values that are used depending on the occurrence of the conditions specified in the contract.
In order to correctly calculate the payback of commercial real estate, you must immediately decide on the indexation option and enter it into a future contract with the tenant. In this case, a change in value will be deemed to be the fulfillment of the terms of the contract and cannot be considered a reason for its termination.
Additional costs for the maintenance of commercial real estate
The owner of the premises is faced with payments that are not included in the lease. Usually we are talking about overhaul, heating, services of a management company. All this significantly affects the average payback period of commercial real estate. Experts recommend compiling a complete list of additional costs, which the investor will have to pay on his own.
The volume of payments differs for all categories of commercial real estate, but the maintenance of offices in the buildings of business centers is recognized as the most costly. The costs of such facilities can be up to 20% of the rental amount. At risk are buildings requiring restoration, buildings erected before the 1980s, and rooms in new premium buildings. In some cases, this is an occasion to think twice about the acquisition.
Real estate tax deductions
The average payback of commercial real estate will depend on the answer to a number of questions related to taxation. It is important for an investor to decide on the method of registering property: for an individual entrepreneur, individual or organization. It is necessary to clearly understand how the premises will be used in the future: for renting or hosting your own business. These are the main criteria that form the amount of tax deductions and affect the payback map of real estate.
Risk of downtime and payback formula
Even highly liquid premises are sometimes forced to wait for a tenant, and a new client may request rental vacations to prepare the business for opening. Losses associated with probable downtime must be included in the payback formula for real estate. The term reimbursement for the purchase of an object is calculated using the expression:
Ni is the number of the year when the discounted value of operating profit becomes positive.
∑NPVi (OP) - the amount of the discounted income i-year of use of real estate.
NPVi (OP) - the amount of the discounted value of profit in the i-year year of use of real estate.
12 - the number of months in a year.
To avoid mistakes in such complex calculations, it is advisable to use a professional Minds Capital real estate payback calculator. Here you can set all the key parameters that are currently known to the investor and get a value close to the real term for the investment reimbursement. If you are interested in how to calculate the return on real estate without delving into economic terms, consult Minds Capital professionals for advice. Our experts will quickly select the best options for investment, quickly calculate the return on investment and answer questions.