Get your cash flow in order: How to calculate the rental income from your investment property
This article was written and published in collaboration with our partner Rentsi Vuokravälitys LKV Oy.
You probably didn't wake up this morning wondering whether index funds are really the best way to invest, or whether there might be better ways to grow your wealth and generate passive income.
If growing your wealth is part of your everyday life, you have probably considered investing in real estate at one time or another, but perhaps you have not yet taken the plunge into becoming a landlord. There are probably as many reasons for this as there are colors in Tikkurila's color charts, but when we talk to novice real estate investors, we often find that they simply do not yet know how to assess the profitability of investment properties.
You understand that simply buying an apartment, making the necessary minor renovations, and renting it out is by no means a guarantee of a profitable investment and riding the waves of passive income streams.
What should a novice real estate investor consider when looking for an investment property that meets the criteria for a good investment product when rented out?
If we examine the key figures for an investment that investors should familiarize themselves with andcommit to memory, we can roughly highlight two important indicators that can be used to verify the suitability of an investment to a certain extent.
- Rental income from investment property
- Cash flow from investment property
Understanding these terms, calculating them, and interpreting the results of the calculations are things that every real estate investor or aspiring investor must learn so well that reviewing investment property listings does not require Googling in order to form an opinion on the suitability of the property in question for one's own investment strategy.
So how do you calculate rental income, and how do you calculate cash flow? What kind of figures should the calculation formula produce in order to determine that the rental income is good?
1 What is rental income?
Rental yield indicates how much of the capital invested in a property is returned as rental income during the year. In simple terms, it is calculated by dividing the rental income by the debt-free price of the property and multiplying the result by 100.
2 Why is rental income important?
Rental yield is one of the most important indicators in real estate investment. It can be used to compare different investment targets and assess the profitability and suitability of an investment for an investor's own strategy. With a few exceptions, a higher rental yield usually means that the investment will generate more money back during the year.
3 How to calculate rental income
There are several formulas and methods for calculating rental income, but here is a formula that, in all its simplicity, can give you a figure on which to base your conclusions and decide whether or not to pick up the phone and start negotiating with the party selling the property:
Rental income calculation formula:
(Rent – Expenses) * 12 / Debt-free price * 100 = Rental yield %
Repetition is the mother of learning, so let's go over the terms used in the formula:
- Rent: The amount the tenant pays you for your apartment each month.
- Expenses: Maintenance fees for the apartment and other possible expenses related to the apartment, such as land rent or telecommunications connection fees.
- Debt-free price: The price of the apartment, which includes the purchase price plus the loan portion allocated to the shares.
Depending on the investment property, when making a purchase decision, it is wise to add the cost of any necessary renovations to the debt-free price. For example, if you paint the walls and replace the kitchen, and these cost €6,000, add €6,000 to the debt-free price. This will allow you to calculate the rental income for the renovated apartment. It is also worth adding transfer tax to the purchase price, even though it does not have much effect on the percentage for apartments in the lower price range.
Here is a concrete example of an investment property being sold by Horisontti Group Oy:
Located in Jyväskylä 57m2 fully rented two-room apartment has a debt-free sale price of €29,000. The maintenance charge for the apartment is €256.5 per month, and the tenant currently pays €549 per month in rent. The rental yield for the apartment is stated as 12.11% on the property's website.
Using the above formula, we can calculate the rental income for the property:
(549 – 256.5) * 12 / 29,000 * 100 = 12.10344
The rental yield for this investment property is therefore rounded to the nearest hundredthat 12.10% – which is an extremely good rental yield for an investment property.
4 Taking loan repayments into account in rental income
Loan repayments are part of the financing costs of real estate investment and are not directly related to rental income. It is standard practice to calculate rental income without taking loan repayments into account. Loan repayments come into play when it is time to look at the cash flow of the property rather than the rental income.
5 What is a good rental yield?
“As a rule, the rental yield of an investment property must be at least 4%, in which case the investor has usually made a longer-term investment and is also seeking an increase in the value of the property. A rental yield of 6-9% can be considered good, and a rental yield of over 10% is an excellentcash flow investment.”
Tero Tupamäki, CEO of Rents.
However, it is important to remember that there are different calculation methods, and this affects the figures. According to the calculation formula presented in this text, the figures obtained can therefore be interpreted as follows:
Poor: 0-4%
- At this level, rental income is often too low to cover all expenses and loan servicing costs, especially if a lot of debt leverage has been used for the apartment.
- The investment may still be profitable in the long term through appreciation, but it will not generate significant cash flow on an annual basis.
Good: 4-9%
- At this level, rental income generally covers expenses and loan servicing costs and also generates a reasonable cash flow.
- This is a realistic and achievable level of return for many investment properties.
Very good: Over 10%
- At this level, rental income is excellent and generates significant cash flow.
- Such properties can be difficult to find, and finding them independently among the apartments for sale often requires detailed market knowledge and a cool head for successful price negotiations.
6 What is the best way to improve rental income?
Buying is the most important step in terms of rental income. Negotiate, haggle, and make good deals. If you own an apartment, renovating it can raise the rent level, which improves rental income.
7 Cash flow is king
In addition to rental income, it is important to monitor the cash flow of your investment. Cash flow tells you how much money you have left each month after rental income and expenses. A positive cash flow means that you receive money from the investment every month. A negative cash flow means that you have to pay for the investment yourself.
How to calculate cash flow:
In all its simplicity, the cash flow of an investment property is calculated by subtracting the expenses related to the property from the rental income received. A simple formula for calculating cash flow can therefore be formulated as follows:
Rental income – (Maintenance charges + Loan repayments & interest + Other expenses*) = Cash flow
*Other expensesmay include, for example, water, electricity, telecommunications, or insurance premiums.
Often, the cash flows reported on investment property listing pages do not take loan repayments into account, and the calculated cash flow is reported using the formula
(Rent – Maintenance charge – Loan repayment & interest – Other expenses = Calculated cash flow
Example:
Let's assume that Joel rents out his investment apartment for €1,000 per month. The apartment's maintenance fee is €200 per month and the loan repayment is €500 per month.
- Rental income = €1,000
- Expenses = €200 (maintenance fee) + €500 (loan repayment) = €700
- Cash flow = €1,000 – €700 = €300
In this example, the cash flow is €300 on the positive side, meaning that Joel's investment earns him €300 per month. Of course, this does not include the capital gains tax that Joel pays to the tax authorities without hesitation!
Cash flow and rental income are well in the black, so is it time to put on your shopping pants and head to the bank?
Rental income and cash flow are extremely important, if not the most important indicators of whether a property can be considered a profitable investment, but they are not the only factors affecting the value of your investment.
The increase in the value of apartments can generate significant additional income in the long term. Apartment prices usually rise in line with inflation, and in some areas they may even rise faster than inflation. It is important to remember that housing prices can also fall, and in recent years we have seen significant regional and city-specific price declines, as shown in this review by Statistics Finland:
“Prices fell by 8.0% in large cities and by 5.7% elsewhere in the country compared to June last year. Prices fell by 10.2% in Helsinki and by 6.4% in Espoo and Tampere.”
Statistics Finland –Prices of owner-occupied dwellings on June 30, 2023
Nevertheless, we do not recommend that your decision to start or not start investing in real estate be tied to current market fluctuations. Real estate investment is a long-term activity. Be patient and focus on long-term goals – don't be distracted by short-term fluctuations.
If you are unsure about anything, consult a real estate investment professional. A dedicated professional will help you find a property that suits your situation and advise you on practical matters, such as arranging financing. In addition, professionals will help you find tenants and manage your investment property comprehensively. In other words, you can step into the shoes of a landlord, but you don't have to walk in them yourself.
So, if you are interested in investment apartments that combine high rental income with strong cash flow, take a look at Horisontti Group's investment apartments andjoin the investment apartment guard.If you want to sleep peacefully at night and outsource the management of your investment apartment, Rentsin Huoleton management service may be just right for you. If you have questions about rental apartment brokerage and management, please contactTero!
At Horisontti, we help you find investment properties that suit your needs, answer questions about specific properties, housing companies, or anything else related to real estate investment. Questions are only silly in the mind of the person asking them, so feel free to send a message about anything to Aarne on WhatsApp!
Rentsi and Horisontti operate together, so we guarantee that purchasing and managing your first investment property couldn't be any easier. Contact us and let's get your journey as a property investor off to a profitable start!