The idea sounds simple: simply use a rented property as a capital investment.
First: take out a loan. Second: purchase the property. Third: let the tenant pay off the loan and in the end be able to call the property their own.
This or something similar might be your first thought when looking for a tangible investment. On the one hand, you’re not entirely wrong. On the other hand, there are a few other points to consider before you try your hand at being a real estate investor.
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Rented property as an investment instead of as residential property
There are numerous ways to invest money in the financial market. From stock savings plans to insurance to cryptocurrencies or real estate, many things are possible. While a mixture of different options is generally recommended, a rented property seems more tangible for many people. Complicated financial products tend to be confused. But is it really that simple? Based on the thought: “My tenant is paying for the property!”
You are not wrong, but we would like to point out a few important points:
Repairs as an unforeseen factor
The property has been purchased, the tenant has moved in and you, as the new property owner, are happy. A few months after moving in, the phone rings and the angry tenant calls. The heating is broken.
As the landlord, you have to pay for the maintenance/repairs. So you order the tradesman. The bill comes to several hundred euros. And you’ve only just received your first rent. And this in turn goes almost entirely towards the loan repayments.
Many people before you have experienced something similar. Unfortunately, repairs are a constant occurrence in real estate. They are part of an investor’s everyday life and should be included in capital planning from the start. If you plan early, you will still not be happy about necessary repairs to your property, but you will then be able to afford them. Of course, they also increase the value of your property, which you can then take into account when selling or renting it out again.
Capital service requirements for investors and owner-occupiers
Capital service refers to all interest and repayment payments that you pay to the bank (usually) every month in the form of an installment. Before granting the loan, the bank checks whether you can afford the loan with your current income. Of course, rental income is taken into account, but you should be able to service the loan even without rental income.
While you can compare the loan rate with the basic rent for a property you live in yourself, there are additional costs for a rented property, some of which you can pass on to the tenant, but which you must include in your calculations.
As an investor, the bank will look at you more critically. There are several reasons for this.
While you are responsible for ensuring that everything is well looked after in your property, in a rented apartment you are dependent on the tenant to take proper care of it. And since you won’t be checking in every week, you are “blind” and have to trust the tenant’s behavior.
In addition, the bank does not want to “take risks” for you and therefore often requires higher credit standards. This means more monthly surplus, more equity investment, or a higher repayment.
As an investor, there are essentially three motivations for investing in real estate:
- the increase in value of the property for a later sale,
- a monthly surplus (cash flow) to save new equity,
- a solid pension plan to be able to live off rental income in addition to the usual pension.
All honorable reasons – but the banks also want to see an increased commitment from you.
Factor in vacancies
As long as the rented property generates monthly income, you as the landlord are reassured because the financing is secured. But what happens if a tenant moves out and there is no immediate replacement tenant? Or if the apartment needs to be renovated/repaired after the move-out and this takes a long time? The vacancy of a property should be factored in from the outset and included in the investment planning. As the owner, can you afford the financing even if the rental income is lost for several months? So before you buy the property, you should have a corresponding financial cushion. Because the banks also examine this scenario you should have a good answer to this question.
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Equity in rented properties – how much do I need?
For a rented property to be worthwhile as an investment, you should think about the points mentioned above beforehand.
Of course, every investor wants to invest as little equity as possible when buying a new property. The less you invest, the more return you can achieve and the more you may have available for the next project. 110% financing is often asked for here. But look at it from a bank’s perspective. Why should a bank take on the risk for you with 10% over the purchase price? Why should they believe in the project more than you do? And the bank wants to see that you believe in the project in the form of invested equity.
So if you are just starting as an investor, it will be very difficult to get 110% financing. This is possible if there is additional security, such as free mortgages on other properties (for example, your parents’) or other valuable assets that you can provide to the bank as security.
Without additional security, you will need equity at least equal to the additional purchase costs. Depending on the bank and the property, however, an additional 5-10% may be required. This is where the idea of ”the tenant will pay off the property” often fails!
Conclusion: the rented property as a capital investment
In conclusion, it can be said that a rented property can be a worthwhile investment if enough effort has been put into planning beforehand. But that is exactly the be-all and end-all!
- Take your time and calculate the eventualities as best as possible.
- The time you invest beforehand will be saved twice or three times as much later.
- Not to mention the spared nerves…
If you are interested in building or buying a property, look at our construction lexicon. There you will find a lot of further information on all topics related to construction financing.
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