Investing in rental properties remains one of the strategies chosen by both small and large investors to generate returns without taking on significant risks.

Buying a home is one of the most important investments any family makes in their lifetime. But the opportunity to find a home isn’t the only thing the real estate market has to offer.

Residential and commercial properties are often sought after by both small and large investors, who see this type of property as a good way to generate a return on their investment without too much effort.

That is what is measured by what is known as rental yield—or, in other words, the concept that relates the cost of the investment to the returns it generates.

Understanding how to calculate the profitability of an apartment, what factors influence it, and whether it’s possible to increase that margin are just a few of the questions that can help determine whether it’s profitable to buy an apartment to rent out.

How to Calculate Rental Yield

The idea of buying a house as an investment sounds very appealing. But before committing to such a significant expense—especially when the ultimate goal is to rent it out—it’s important to carefully analyze the investment. Determining whether it’s profitable isn’t an exact science, but analyzing the rental’s profitability is essential to clearly understand whether, at first glance, the decision is the right one.

This concept links the purchase price of a home to the annual rental income it generates and is expressed as a percentage. In fact, it is the benchmark used by the Bank of Spain. The formula is simple:

Return on Investment = Rental Income / Property Price × 100

In other words, it is the ratio of rental income to the purchase price. For example, for a property priced at 120,000 with a gross annual rent of 7,800€ (650 × 12), the gross rental yield would be 6.5%.

However, if we want to determine the true value of the transaction, it would be advisable to calculate the net rental return. In this case, we would need to subtract the rental expenses—that is, those associated with the property (insurance, homeowners’ association fees, etc.) and taxes—from the gross rental income.

Similarly, the purchase price should be increased by the purchase expenses, which are generally estimated at 10%.

Using the same example and assuming annual expenses of 1,500€, the calculation would be as follows: 7,800 – 1,500 / 120,000 + 12,000 = 4.77%.

In any case, beyond the concept of rental profitability itself, there are other factors that provide insight into whether it is profitable to buy an apartment to rent out.

Whether or not there is a mortgage, what is known as cash flow (that is, the net amount generated over a given period from renting out a property after purchasing it), the ROI (the percentage that measures the return on investment over a year) or the PER (that is, the number of years it would take to pay off the price of the home through rent, which corresponds to the inverse of the gross return formula) are just a few of them.

Is it profitable to buy an apartment to rent out?

Real estate has traditionally been an attractive asset as a source of extra income for small investors. Although it can be a drawback during times of crisis—in terms of liquidity—the fact is that rental returns make “buy-to-rent” an option worth considering for savers who can afford to invest in a second home.

Once you have a clear understanding of the concepts related to rental profitability, it will be easier to determine whether or not buying a property is a wise decision. There are even mobile apps designed to provide advice on this topic, although it’s also a good idea to consult reputable organizations to gauge the health of the market.

The Bank of Spain publishes quarterly data on the total annual return on housing—that is, the return obtained by adding the rental income to the increase in property prices (known as capital gains).

According to the institution’s figures, the return on housing reached an average of 5.85% last year. In the fourth quarter of 2020 alone, the portion attributable to rent stood at 3.7%, with the remainder attributable to price appreciation.

Although the figures are significantly lower than those recorded in 2018 and 2019—when the gross rental yield stood at 4% and 3.8%, respectively, and the annual return reached 10.6% and 7.4%—real estate remains an attractive asset, although its performance varies depending on the city where you choose to invest.

Madrid, Barcelona, and San Sebastián, for example, are the places where it is hardest to recoup one’s investment. However, in other cities such as Lleida, Murcia, Huelva, and Tenerife, the situation is exactly the opposite.

Investing in Rental Properties: Recommendations

Calculating the return on investment for an apartment is not a foolproof formula. That’s why, before investing in rental property, it’s a good idea to think the decision through and take certain factors into account. It’s important to analyze the price and its potential appreciation, as well as to explore all financing options if you need a mortgage.

Having clear goals, carefully choosing the location and features of the property (generally, smaller homes offer a higher rental yield), as well as considering all the associated expenses and avoiding purchases that require a monthly investment exceeding 40% of your income—these are just a few of the basic recommendations.

If your goal is to increase the value of your investment, it’s a good idea to maintain a positive attitude toward potential tenants and make any necessary renovations or repairs to secure better rental terms.