How to calculate the return on a property investment
Before buying a property as an investment, one of the first questions to ask yourself is: what return can it generate?
The purchase price is not enough to answer that. To calculate a property return you have to analyse the income the property can generate and the costs attached to the investment.
In this article we explain, in simple terms, how to calculate the return on a property investment and which factors to consider before buying.
What is a property return?
A property return shows how much income a property can generate relative to the capital invested.
For a home intended for letting, it is calculated mainly from the annual income the property generates and the cost of acquiring it.
There are two main calculations: gross yield and net yield.
How to calculate the gross yield
The gross yield gives you a first estimate of a property’s return.
The formula is:
Gross yield = (annual rent / purchase price) × 100
For example, if you buy a home for €200,000 and let it for €1,000 a month:
€1,000 × 12 = €12,000 per year
(€12,000 / €200,000) × 100 = 6%
The property would have a gross yield of 6% a year.
It is a useful calculation for comparing properties, but it does not account for the costs attached to the investment.
How to calculate the net yield
To get a better picture of a property’s performance you have to calculate the net property yield.
The simplified formula is:
Net yield = ((annual income − costs) / total investment) × 100
The costs you need to consider may include:
- Taxes.
- Service charges.
- Insurance.
- Maintenance and repairs.
- Letting management.
- Void periods.
- Renovation.
- Financing costs.
It is also important to account for the up-front costs of the purchase, since the capital invested can exceed the price of the property itself.
Which costs should you include when calculating a property return?
One of the most common mistakes when calculating the return on a property investment is stopping at the purchase price and the rent.
For a more realistic estimate you have to consider both the up-front costs and the costs the property will carry while it is being operated.
It is also worth allowing for possible months without a tenant and for exceptional costs, such as a repair or a renovation.
The more realistic the estimate, the more useful the calculation will be when it comes to making a decision.
A worked example of a property return
Imagine a €200,000 home generating €12,000 of rent a year.
If annual costs come to €2,000, the income after costs would be:
€12,000 − €2,000 = €10,000
The return on the purchase price would be:
(€10,000 / €200,000) × 100 = 5%
So while the gross yield was 6%, once costs are deducted we arrive at a return of 5%.
This simple example shows why it matters to analyse the costs before judging an investment.
Conclusion
Knowing how to calculate the return on a property investment lets you compare properties and decide with better information.
The gross yield is a good starting point, but the net yield gives a more realistic view by taking the costs of the deal into account.
If you are thinking of investing in property, always analyse the price, the potential income, the costs and the potential of the property before deciding.
At Just Invest Here we help domestic and international investors analyse property opportunities in Valencia and other selected markets, taking their objectives, budget and investment strategy into account.
A good investment starts with knowing its numbers.
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