How to analyze the profitability of a rental property

How to analyze the profitability of rental property

More and more savers are letting themselves be tempted by rental investment, seduced by the prospects of return and the creation of real estate assets. But behind the beautiful promises there are also risks and pitfalls to anticipate. Yet, effective management of a rental property requires cost control. To do this, you will need to know how analyze the profitability of rental property.

Before any purchase, it is essential to methodically analyze the projected profitability of the operation to determine if it is of interest.

In this researched article, Finance de Demain offers you a procedure to follow 10 steps to evaluate serenely profitability of rental property. But before we start, here's how Investing in real estate step by step

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 Read on…

👉 1. Estimate the average rent per m2 in the neighborhood

The basis of your analysis will be to estimate the average rent per m2 that you can expect in the targeted area. 🏡

To do this, consult the real estate advertisements in the area for properties similar to yours in terms of surface area, services and condition.

This will give you a realistic range of potential rent per m2. For example between €10 and €12/m2 for standard.

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👉 2. Calculate the theoretical annual rent

From the average rent per m2, it is easy to calculate the total theoretical annual rent that your property could bring in. ✅ Just multiply the living area by the average rent per m2.

Property rental

Example: 70 m2 x €11/m2 = €770 monthly rent, or €9 annual rent.

Compare this theoretical rent to those of similar advertisements to validate that you are in the nails.

👉 3. Integrate a potential vacancy rate

To analyze profitability of rental property, you cannot hope to have your property rented 12 months out of 12 each year. 📉

It is therefore necessary to include in your forecasts a rental vacancy rate, corresponding to the periods when the accommodation could remain unoccupied between two tenants.

A rate of 5 to 10% is reasonable depending on the attractiveness of the sector. Over 12 months, count 2 to 3 weeks of interruption.

Adjust your forecast annual rent by lowering it by this vacation percentage for more realism.

👉 4. Subtract landlord charges

All costs are not the responsibility of the tenant. As the owner, certain charges will remain your responsibility. 🧾

The main ones are:

  • Property tax
  • Condominium fees
  • Management fees if applicable
  • Minor repairs and routine maintenance
  • Insurance (non-occupant owner, unpaid rent, etc.)

Estimate the annual total and deduct it from your net rents to obtain your income after charges.

👉 5. Calculate the necessary personal contribution 

If you need to borrow, your future rental income will influence the amount you can borrow. 🏦

The bank will generally lend for a maximum of 15 years, and will require a personal contribution of at least minus 10 to 20%.

The higher your projected rents, the lower the down payment requested. Estimate your minimum contribution based on the purchase price of the property. It will have to be included in your financing plan.

👉 6. Integrate the cost of a possible loan

In the event of a loan to partially finance the purchase, you will have to repay the loan monthly. 💸

Depending on the rate and duration, estimate the annual cost of this loan and also deduct it from your rental income.

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This will give your net income after rents, charges, and cost of credit. A key number. Also remember to include borrower insurance.

👉 7. Add tax benefits

Fortunately, certain tax advantages come to improve the profitability of the operation. 💶 Loan interest is partly deductible from your rental income.

And you can also deduct the depreciation of the property from your overall income. Calculate the total annual tax gain and add it to your net income. This gives your result after taxes.

👉 8. Calculate the gross rate of return

You now have all the elements in hand to calculate the gross profitability of your real estate project before taxes. ✅

All you have to do is: Annual net rental income / Purchase price of the property.

For example: €7 net annual rent / €000 initial investment = Gross profitability of 100%. This figure will allow you to compare the profitability to other investments.

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👉 9. Calculate net profitability after taxes

By carrying out the same operation after taking into account taxation, you obtain your rate of return net of tax. It is he who will really count in your pocket.

For example: €7 of annual net income after tax benefits / €500 invested = 100% of net profitability.

👉 10. Analyze sensitivity under different scenarios

Test different scenarios to challenge the profitability of your project: ✅

  • Increase in rates and monthly loan payments
  • Lower expected rents
  • Increase in vacation rentals
  • Unexpected increase in charges
  • lower tax benefits

Play on these parameters in a negative direction to check the solidity of your project in case of unforeseen. If the profitability remains correct, you have room.

Conclusion

Analyzing in depth the potential profitability of a rental property is essential before any investment. Carefully assessing the relationship between forecast revenues and costs generated allows you to make an informed and profitable choice in the long term.

Although it requires careful work, don't neglect this crucial step. Take the time to carefully project your future cash flows, estimate your costs and study the financial indicators. Seek advice from experts if necessary.

A profitable investment is the key to generating solid additional income and enhancing your assets. So before you rush headlong, carry out an in-depth profitability analysis. It is the best guarantee of a successful real estate transaction which will bring you serenity and return on investment.

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I hope that this conclusion highlights the importance of carefully analyzing the profitability of a rental real estate project. Please feel free if you would like me to modify or refine certain elements.

FAQ

Q: What are the main profitability indicators?

A: The internal rate of return (IRR), cash flow, occupancy rate, operating profit and self-financing capacity.

Q: How do I calculate the internal rate of return (IRR)?

A: IRR is calculated by taking into account the net cash flow generated each year and the initial costs. It makes it possible to measure overall long-term profitability.

Q: What is rental property cash flow?

A: Cash flow is equal to the rent received minus the owner's charges and any loans. It represents the cash generated by the property each year.

Q: What occupancy rate are we aiming for?

A: An occupancy rate of 95% is considered optimal. A rate below 85% over several months is worrying and should prompt you to react.

Q: How to optimize operating income?

A: By negotiating leases at market prices, controlling your charges, and limiting vacancy periods between two tenants.

Q: What is self-financing capacity (CAF)?

A: The CAF corresponds to the cash flow from which the repayment of the borrowed capital is subtracted. It reflects the capacity of the property to cover its costs with its own funds.

Don't hesitate if you have any other questions! Before you leave, here are some Tips for succeeding in entrepreneurship.

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