# Economics of buy-to-let (investment) flats

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?

• You might want to get some estimates/quotes from insurance agents and property managers/landlord service, to firm up your numbers. If you have a specific property in mind, you will also want to have a thorough home inspection done to identify any possible issues. Commented Apr 12, 2012 at 14:32

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.

• Got that yeld formula from Succesfull property letting, chapter 2. You will notice I also calculated the yeld over my own capital (1.2%) but I believe the calculation should be over the property price as it affects my risk (I will have to pay the bank that amount even if the property price dips). On the other hand, if the property increase in value, yeld increases. Commented Apr 11, 2012 at 16:45
• The management fee covers maintaining the common areas of the building (like removing the tons of snow that falls over here ever winter, among other things). I also find it expensive but it is mandatory and charged by size of the flat. Some flats have a cheaper fee/sqm and I'll be looking into that as one of the factors on deciding where to buy. Commented Apr 11, 2012 at 16:49

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.

• So, with a yeld of 0.36% and an inflation rate of 3.42% I am actually loosing 3.06% of the property value per year? Or 2.22% of my own capital if I look only at the 45K down payment? That assuming the properly value stay stable... Commented Apr 12, 2012 at 6:39
• No, but it means you can expect the value of the house to raise by 3.42% per year AS WELL AS THE RENT. Yes, you make small profit now, but in 10 years the rent will be a lot higher and your mortgage payment not (with same interest). In 20 years most of the then a lot larger rent is yours to keep. The propert value staying stable is a DECLINE over time, as the property value "stable" would mean "going up as per inflation". If it stays the same in whatever currency you use, it actually declines in real value. Commented Apr 12, 2012 at 6:47
• Ok, but for the purpose of my yeld calculations for the current year I don't need to consider inflation as it would not increase or decrease my capital (the house would appreciate at least the same amount as inflation, as would rent, making thing even) Commented Apr 12, 2012 at 18:01
• But then real estate investments are not current year. They are long term. All of them. Yes, profit is small, but it WILL grow over time, as will the value of the house (as investment, obviously - rental property follows different rules than own use housing). Commented Apr 12, 2012 at 18:10

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?

"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.

• There is at least a real state agent that will guarantee the rent payment for the first year. If the tenant they found defaults they pay the rent. Not paying your rent over here mean you won't get any credit anywhere for the next 5 years, if a proper background check was done to start with, chances a regular person will want that to happen are small. Commented Apr 11, 2012 at 16:32
• 30yr fixed interest? Do they offer that on the US? I believe over here the maximum is 5 years, with a premium over the regular interest rate. Commented Apr 11, 2012 at 16:34
• 30 year fixed is the more common mortgage here. ARMs (adjustable rate) were popular for a time, but with the mortgage crisis and now fixed rates so low, the fixed are most popular, either 30 or 15 year. Our current rates are about 4% for 30, 3.5% for 15. If your rate is variable, that's another risk you are taking. If rates go up, your cost goes higher and you may not break even at all. Commented Apr 11, 2012 at 17:10
• A longer mortgage would provide more free cash flow but it would also be slower to build up equity... But I like the idea of a fixed rate for the initial years as it may help me sleep peacefully. Commented Apr 12, 2012 at 6:44
• @CleberGoncalves - I edited a response to your comment. Too long for down here. Commented Apr 12, 2012 at 16:10