The dream of many Spaniards is to have a home to rent that provides you with extra passive income. If you are considering that possibility, do not take the step of buying a home without finding out how profitable it is. To find out, read this guide in which we explain what it is and how to calculate the profitability of a rental.
Investing in a home is a momentous decision for your life. A purchase cannot be taken lightly: you must base your decisions on mathematics.
We always explain to future buyers that it is not the same to buy a home, where it is very important to feel a connection with the property, than to invest.
If you want to bet on the rental world, your most emotional side has to disappear to give way to a more critical and business mind, taking into account factors such as gross and net profitability, concepts that we will explain later.
So open the calculator and join us by reviewing all the basic concepts to calculate the profitability of your rental with some simple calculations.
1. What is the profitability of a rental?
When we talk about rental profitability, we are referring to the term that relates the cost of an investment to the future benefits that we are going to obtain. In other words, we are talking about the economic return that you will obtain once you have rented your home as a long-term or vacation rental.
The positive thing is that you can do this calculation before making the investment, which will help you make a better decision.
1.1 How does knowing the profitability of a rental home help us?
- To predict in the medium term how profitable it will be to invest in one asset or another if you are hesitating between several options.
- To find out what is the maximum price that you can pay for a home, taking into account what is the cost that you will pay for it and how much profitability you will obtain for the future.
- To calculate if it is more appropriate to continue maintaining a home as a rental or to sell it according to your needs and based on fluctuations in the real estate market.
2. What is it and how is the gross profitability of a rental home calculated?
Gross profitability is a concept that relates the cost of housing (or investment cost) with the benefit we obtain. Profitability is measured in percentage, being the result of the following formula:
Gross Return = Annual Rental Income/Home Price x 100
We have to divide the income that we will receive annually for renting that home by the price at which we bought the property, and finally multiply the result by 100.
We leave you below an example of what a real calculation of a house in Malaga would be like:
Imagine that you are the owner of a 2-bedroom house in the center of Malaga that you rent for €800 per month, which translates into €9,600 per year. The cost of the house, when you bought it, was €150,000. Therefore, we will divide €9,600 / €150,000 and multiply it by 100, the result being a return of 6.4%.
Is that calculation real? Not entirely, so you may already be imagining: other expenses associated with the purchase, fixed expenses and maintenance of the house (repairs, for example) are not taken into account.
3.What is net rental profitability and how is it calculated?
The net return on a rental is a more realistic percentage of the actual benefits you get from renting your home, since it takes into account how much you earn from renting the property but subtracts the fixed costs (annual or monthly) that you face.
What expenses are taken into account then? The initial investment expenses (such as the notary, for example) are added to the price of the house and the fixed and maintenance expenses that you pay each year are subtracted from the annual benefits.
The formula would be expressed as follows:
Net profitability = (Annual rental income - maintenance and fixed expenses) / (home price + purchase expenses) x 100
3.1 What are the expenses of the investment or purchase?
In this bag we can put all the expenses that are linked to a purchase.
We could highlight the following:
- Property Transmission Tax (ITP) if it is a second-hand home or VAT if it is a new construction.
- would notary
- Property registration.
- Management or commission to real estate agency.
- The expenses associated with the mortgage, in case you need it.
- Investment in furniture or reforms to condition the property.
This amount must be added to the initial price of the home. Continuing with the previous example, the flat in the center of Malaga that initially cost us €150,000 has associated initial expenses of €35,000, so its real value is €185,000.
3.2 What are the fixed and maintenance costs of a property?
Each year, you must recalculate these figures, as they will vary quite a bit, taking into account the needs of the property.
On the one hand, we have fixed expenses, in which we group the following items:
- The Property Tax (IBI).
- Home insurance, non-payment insurance or any other insurance associated with the property.
- Community fee.
- The mortgage fee, if you had to request it at the time to finalize the purchase or its reform.
On the other hand, we have the maintenance expenses that are linked to keeping the property in good condition:
- Spills for the good maintenance of the block and the community.
- Property repairs due to breakdowns or unforeseen incidents.
- Cleaning, painting or repair costs if the tenant leaves.
3.4 How is net profitability calculated?
Continuing with the previous example, let's calculate the expenses so that you can understand what the profitability of a home would be.
Suppose that the annual fixed expenses are the following: €400 in community expenses, €370 in insurance fees, €320 in IBI expenses and €3840 per year in mortgage.
Unforeseen expenses are added to this figure: €330 for changing a washing machine that stopped working.
We would have to subtract these fixed and maintenance expenses from the benefits that we previously calculated of €9,600, which means that the real benefits would be €4,430. We divide this amount by the real price of the property (€185,000 after purchase and renovation costs) and multiply it by 100, obtaining a net return of 2.39%.
How do you know when the profitability obtained is optimal? It all depends on what your expectations are and also, each area yields different returns.
To optimize the results of this calculation and make the right decision, we recommend that you seek advice from a buyer's agent and a rental agent specialized in the search area so that they can refine the results, and thus make your decision more accurate.
