The Return On Real Estate Is Also A Question Of Valuation. The prices for houses and condominiums have risen rapidly in recent years, especially in metropolitan areas. If you want to buy now, you should pay attention to the evaluation. The greater the disparity between purchase price and rent, the lower the expected return on a property. Almost everyone who is liquid, creditworthy, or both currently seems to be on the hunt for their own four walls or wants to purchase a property as an investment. Low interest rates, good conditions on the labor market, rising wages and moderate economic growth make it possible. It is a natural law of the economy that in such an environment the prices keep on rising. A scarce supply of living space that cannot be expanded quickly meets a rapidly growing demand.
A sensible evaluation as the basis for a successful investment
For investors who want to acquire and rent out a property as an investment property, such average considerations are basically pointless. Because, unlike with liquid investments, they cannot buy the entire market anyway and thus diversify their risk. An apartment building or a condominium are single objects. Their individual characteristics and evaluation alone determine the success of the investment. Where the market as a whole goes is secondary at best. Location factors that favor rising purchase prices and rents are increasingly attractive locations, a strong local economy and a growing population. On the other hand, these attributes are of little use if the residential property is bought too dearly. Then the return is low and the risk of loss is high, if, for example, there are longer rental losses. A sensible valuation is therefore the key factor for all real estate investors.
Absolute purchase prices say nothing
Ranking lists of property prices appear regularly in the media. They show how high the square meter prices are in individual cities and districts. If you want to buy a house, you can get an idea of the financial burden that you will face. The price alone does not say anything about whether a purchase is worthwhile.
The earnings factor or multiplier
If you divide the purchase price by the annual net cold rent, you get a multiple of the annual net cold rent. This key figure is also called a multiplier or profitability factor. The bigger it is, the more expensive the object – and vice versa. As a rule of thumb, buyers should only pay more than 20 times the annual net rent in exceptional cases, for example if a particularly good location justifies a higher valuation.
Also not to forget that; IMPORTANT! As with bonds, if the risk increase then the higher expected gross initial yield on a property expected. Conversely, a higher valuation (and therefore a lower return) is an indication of a lower risk. But if the rating is too high, it becomes a risk itself.
The net rental return
It sets the annual rent in relation to the purchase price, including all one-off and ongoing ancillary costs. The brokerage and notary fees as well as the fees for the entry in the land register are added to the purchase price. The administration and maintenance costs (6 to 12 dollars per square meter per year) are deducted from the net rent. The net rental return should be at least 4 percent for the investment to be worthwhile. If the return factor is below 20, it is often higher.
The return on equity
The return on equity indicates the average annual return on capital employed. All income and expenses in the investment period including loan costs are taken into account. Investors can compare real estate investments with other investments based on the return on equity. It should not be forgotten that the result is always a forecast calculation. Nobody knows whether rents and resale values will develop as expected. The return on equity reacts more strongly to deviations from the expected values, the higher the proportion of debt. On the one hand, the return on equity can be leveraged with a high financing share. On the other hand, the risk also increases considerably.
The income factor and gross initial yield are easy to calculate. The property price is known and buyers can easily determine the local net rent with the help of rent indexes and current rental offers from newspapers and the Internet. However, both key figures only provide an initial indication of the valuation of a property. Whether an apartment or a house is worthwhile for a buyer in an individual case depends on a number of other factors: For example, whether he uses the property himself or rents it, what his credit terms look like and what tax advantages he benefits from.