Economics of buy-to-let (investment) flats

Question

I'm trying to figure out whether it is a good business to buy a flat and rent it out.

These are the numbers I have so far:

Costs

• Property: 150,000
• Downpayment (30%) : 45,000
• Interest rate/year: 4% (less right now but I'm sure it will rise soon)
• Interest: 4,200
• Property Insurance: 100 euros/year (wild guess)
• Landlord calls (to be cared for by a 3rd party firm): 300 euros/year (another guess)
• "Finder's fee" paid for real state agent to find a tenant: 700 euros + 23% vat (assuming I would need to find a new tenant every year but the flat would be occupied all the time)
• Property management fee/year: 2400

Expected Rent: 8400 euros/year

Yield = (Rent - Costs) / Property value

Yield = (8400 - 7861) / 150,000

Yield = 0.36%

That would mean a net increase in wealth of 539 euros (150,000 * 0.36%)

It would also mean a gain of 1.2% on my own capital invested (45,000 / 539)

I'm sure some of the numbers above will be very off but I hope they will serve for the example.

Questions:

• Am I really making money on that scenario?

• I live in Finland and inflation here was 3.42% last year.

  • Should I take inflation into account on my calculations?

• Should I take 'cost of lost opportunity' into account?

  • If so, what could I compare it against?

The idea behind it is to slowly build up capital on the flat to eventually remortgage it and buy another one, building up a 'portfolio of flats' in the long run.

The rent is enough to pay the interest, but I would have to supplement the payments to cover the principal.

• How do I account for that investment on this scenario?

  • I can cover the payments, but is that a sound financial decision?

• How many years mortgage should I take?

Answer 1

Surely the yield should be Yield = (Rent - Costs) / Downpayment ? As you want the yield relative to your capital not to the property value.

As for the opportunity cost part you could look at the risk free rate of return you could obtain, either through government bonds or bank accounts with some sort of government guarantee (not sure what practical terms are for this in Finland).

The management fee is almost 30% of your rent, what does this cover? Is it possible to manage the property yourself, as this would give you a much larger cushion between rent and expenses.

Answer 2

"but the flat would be occupied all the time." Famous last words. Are you prepared to have a tenant move in, and stop paying rent? In the US, it can take 6 months to get a tenant out of the apartment and little chance of collecting back rent. I don't know how your laws work, but here, they do not favor the landlord. The tiny sub 1% profit you make while funding principal payments is a risky proposition. It seems to me that even normal repairs (heater, appliances, etc) will put you to the negative. On the other hand, if this property has bottomed in terms of price and it rises in value, you may have a nice profit. But if you are just renting it out, it feels like it's too close to call.

By the way, if you can go with a 30yr fixed, I'd suggest that. This would get you to a better cash flow sooner. A shorter mortgage simply means more money to principal each month.

EDIT - as far as equity goes, at the beginning it seems the equity build up is really from your pocket, definitely so by switching from the 30 to the 15. What is your goal? The assumption I may have made is you wish to be a real estate investor with multiple properties. Doing so means saving up for the next down payment. Given the payoff time even if the property ran a high profit, I imagine you'd want to focus on cash flow, minimize the monthly expense, maximize what you can take each month to save for the next down payment. It's your choice, years from now to have one paid property, or 3 properties each with that 30% down payment, and let time be your friend.

Answer 3

Lucky you - here where I live that does not work, you put money on the table year 1. Anyhow...

You HAVE to account for inflation. THat is where the gain comes from. Not investment increase (value of item), but the rent goes higher, while your mortgage does not (you dont own more moeny in 3 years if you keep paying, but likely you take more rent). Over 5 or 10 years the difference may be significant. Also you pay back the mortgage - that is not free cash flow, but it is a growth in your capital base. Still, 1 flat does not make a lot ;) You need 10+, so go on earning more down payments.

Answer 4

Seems like a bad deal to me. But before I get to that, a couple of points on your expenses:

• Insurance: 100 euro/year? That seems WAY low.You really need to research this. Of course if varies from place to place, but here in the US it would be at least 10x that.
• Are there real estate property taxes to account for?

Onward.
You value a property by calculating its CAP rate. This is what you're calculating, except it does NOT include interest like you did -- that's a loan to you, and has no bearing on whether the unit itself is a good investment.

It also includes estimations of variable expenses like maintenance and lack of income from vacancies. People argue vociferously on exactly how much to calculate for those. Maintenance will vary by age of the building and how damaging your tenets are. Vacancies vary based on how desirable the location is, how well you've done the maintenance, and how low the rent is.

Doing the math based on your numbers, with just the fixed expenses: 8400 rent - 2400 management fee - 100 insurance = 5900/year income. 5900/150000 = 0.0393 = 3.9% CAP rate. And that's not even counting the variable expenses yet!

So, what's a good CAP rate?
Generally, 10% CAP rate is a good deal, and higher is a great deal. Below that you have to start to get cautious. Some places are worth a lower rate, for instance when the property is new and in a good location. You can do 8% on these. Below 6% CAP rate is usually a really bad investment.

So, unless you're confident you can at least double the rent right off the bat, this is a terrible deal.

Another way to think about it
You're looking to buy with your finances in just about the best position possible -- a huge down payment and really low interest. Plus you haven't accounted for maintenance, taxes (if any), and vacancies. And still you'd make only a measly 1.2% profit? Would you buy a bond that only pays out 1.2%? No? What about a bond that only pays 1.2%, but also from time to time can force YOU to pay into IT a much larger amount every month?