Calculating rental property returns: why 5.6% is actually negative

A €300,000 property yielding €1,400 a month looks like a 5.6% return. That's the sum almost everyone makes: annual rent divided by purchase price.

Worked through with operating costs and mortgage interest, the cash flow is minus €118 a month.

That gap isn't because the example was chosen unfavourably. It's because three different returns exist and most people calculate the wrong one.

The example

That purchase-cost percentage is an estimate. For a property you won't live in, transfer tax is higher than for a primary residence, plus notary, valuation, agent and advice fees. Look up the current rate before calculating; it's tens of thousands of difference in starting capital.

Return one: gross

Annual rent divided by purchase price

€16,800 / €300,000 = 5.60%

This is the figure in advertisements and the one agents quote. It's wrong for three reasons: no costs, no vacancy, and purchase costs are missing from the denominator.

Gross yield is useful for comparing properties against each other. It isn't useful for deciding whether something is a good investment.

Return two: net

Now the costs. For a €300,000 rental property:

That's 46% of the rent. Nearly half.

Net return on total investment, including purchase costs:

€9,084 / €336,000 = 2.70%

Not 5.6%. Nearly half as much, and that's before the mortgage.

That 46% cost figure isn't exaggerated. Managing it yourself saves the management fee but costs time. Being lucky with tenants means less vacancy, but that isn't a plan. And 1% maintenance a year is on the low side for a thirty-year-old property.

Return three: on your own money

This is the figure that actually matters, because you didn't invest €336,000 but €126,000.

At a €210,000 mortgage at 5%:

That's minus €118 a month. The property costs you money every month.

Return on your own money: −1.12%.

Note what's happening. The leverage that makes property attractive works both ways. As long as your net rental yield exceeds your mortgage rate, leverage magnifies your return. Fall below it and it magnifies your loss.

The break-even point

At which mortgage rate is the cash flow exactly zero?

€9,084 of net rent divided by €210,000 of mortgage = 4.33%

Above that rate the property costs you money every month.

This is the figure to calculate first for any property you're considering. If the rate you can get exceeds your net rental yield, you're buying a monthly expense.

And note: buy-to-let mortgages typically carry higher rates than owner-occupier mortgages, and the maximum LTV is lower. Calculate with a quote, not with advertised rates.

Where the return actually comes from

If the cash flow is negative, why does anyone buy this?

Because the return comes almost entirely from appreciation.

At 3% appreciation you reach over six percent, which is a fine return. At zero percent you lose money.

That makes rental property at current rates a bet on the housing market rather than an income source. That isn't necessarily wrong, but it's something other than what most people think they're buying.

Leverage also explains why the effect is so large. Your appreciation calculates on the full €300,000 while you invested only €126,000. Three percent on three hundred thousand is €9,000, which is seven percent on your own money. The same leverage magnifies your loss when markets fall.

Property versus an index fund

An honest comparison is difficult, because the two differ on four points rarely placed side by side.

Leverage. With property you borrow 70% of the purchase price. With an index fund you borrow nothing. That doesn't make property better, only more volatile in both directions.

Time. An index fund asks virtually nothing after purchase. A rental property demands maintenance, administration, tenant changes and occasionally a legal process. Expect a few days a year, and more when things go wrong.

Diversification. One property is one object on one street in one city, while compound growth in a diversified fund runs across thousands of positions. A global index fund is thousands of companies across dozens of countries. With property, an empty month or a bad tenant is felt immediately.

Liquidity. Investments sell in a day. A property takes months and several percent in selling costs.

What property offers against that: leverage, and rent that usually rises with inflation. How that compares with dividends as an income source is a comparison worth making.

What the calculation excludes

Tax. Wealth held in rental property falls under different treatment from your own home, and those rules have changed repeatedly in recent years. That belongs inside your net return and falls outside this article. Look up the current treatment or have it calculated.

Repayment. Repaying lowers your interest and grows your equity, but worsens your cash flow in the short term. That's a shift, not a return.

Rent regulation. What you may charge depends on the points system and local rules. A market rent isn't always a permitted rent.

Unforeseen costs. A leak, a foundation problem, a tenant who doesn't pay. With one property you have no diversification to absorb it.

How Gylder fits in

A rental property is the hardest asset to track, because three things move at once: the value, the outstanding balance and the cash flow.

Gylder models a property with its mortgage as it's actually built: multiple loan parts, each with its own repayment type, rate, term and fixed-rate period. The value moves between your own valuations using the official house-price index for your region, so your net position stays right in the years you enter nothing.

That gives you the figure at the centre of this whole calculation: your equity in the property, meaning value minus outstanding balance. That's the denominator of your return on own money, and it changes every month.

And because rent and costs arrive through your accounts, they're included in your spending overview rather than living in a separate spreadsheet.

What this doesn't tell you

The cost items are estimates. Maintenance, vacancy and management vary by property, city and tenant. Use your own figures and err on the cautious side.

The 12% purchase costs is illustrative. Look up the current rate for a property you won't occupy.

Appreciation is an assumption. The table shows how sensitive the total return is to it, which is precisely why you shouldn't fill it in based on the last ten years.

This isn't advice. Whether a property suits you depends on your wealth, your risk tolerance and the time you're willing to put in.

Frequently asked questions

How do I calculate the return on rental property? Three figures. Gross is annual rent divided by purchase price. Net is after operating costs, divided by total investment including purchase costs. Return on equity is cash flow after interest, divided by your own contribution.

What's a good gross yield? Gross says little. In the example, 5.6% gross equals 2.7% net and a negative cash flow. Look at your mortgage rate break-even point.

How much do the costs come to? In the example, 46% of the rent: maintenance, insurance, management, vacancy and local charges. Managing it yourself saves part of that but costs time.

Why is the cash flow negative? Because the net rental yield of 2.7% is lower than the 5% mortgage rate. Leverage then works against you.

Is property better than an index fund? Different, not better. Property offers leverage and inflation protection; an index fund offers diversification, liquidity and asks virtually no time.