Calculation of Return on Equity

Additionally: Take a look at the rent index in your market. In some cases, the current rent should also already be stated in the offer, including the non-recoverable costs. I also forgot: personal maintenance reserve, + rent default risk

It can be put even more briefly: The basic rule for the long-term successful landlord is: liquidity beats profitability. So don’t fool yourself with returns. Especially not with imaginary numbers.

What is posted here partly (content-wise as well as in style) is simply terrible. It’s quite funny what some people here want to tell me about real estate investments, apparently knowing very little about the subject. Just so much: I have been active in the real estate sector for well over 10 years. My personal "balance sheet total" / loan volume is well into the seven-figure range. (I also own other financed properties that I haven’t mentioned in the other thread yet, because otherwise the thread would have been full of these destructive hater comments like HilfeHilfe etc. right from the start). The fact is that simulations I made (much more extensive than posted here) did not exactly match reality. Because reality looks, for me – even if many here evidently cannot come to terms with it or want to deny it – far rosier than roughly estimated in the example, since the actual real estate price development was drastically above 4%. For example, about 10 years ago I bought a property that has now roughly doubled in value. (And when I took out the loans, the rental yield was generally still above 4%. (That is no longer the case now, that’s clear).

Very clearly for everyone:
The example is not an exact yield calculation for a property I want to buy now, but it was meant to roughly show user Tassimat how equity returns of about 20% come about. The real situation AT THE MOMENT looks more like rental yields are lower, but the expected price increases are higher.

@ ghost:
All operating costs are already included in this rough calculation. Apparently, you didn’t read my post properly. If you buy 100 sqm, the 80% obviously won’t work anymore.
What do you expect me to build Excel calculators for??? Calculating a rental yield should be possible in your head, and if you can’t do that, you can also use a calculator. You need to know what the property costs (including incidental costs), how high the estimated gross rent is roughly. From that, you can then derive the desired loan instalment amount (or repayment rate) that you have to inform the bank about. You don’t have to consider more numbers at first.

However, this numerical calculation is not the decisive factor in real estate investments, even though most people waste their time with it and then calculate m2 prices or similar and consider themselves great investors just because they once calculated a rental yield. Much more important is to study the “soft skills” (as I call them). That means connection to public transport/traffic congestion, proximity to shopping centers, traffic noise, etc. – in short location, location, location – (potential future) renovation costs depending on the building materials used, and above all study demographic development. This is the hard and very time-consuming work in real estate investments, not these trivial total number calculations done quietly in your room, where you then calculate a theoretical rental yield or whatever, because these calculations are pointless if you don’t manage to rent the property properly or if unexpected renovation costs arise, etc.


@ chand:
The general main goal should be:
Maximizing returns under the mandatory condition that liquidity is continuously secured. It’s suboptimal to always have very high liquidity but only low returns in exchange.
My financings are roughly cash-flow neutral. Whether I have to add a few thousand in liquidity in one year plays a minor role. On the one hand, the more properties you have, the more the variance of rental defaults, high repair costs, etc. decreases on the overall portfolio level, so a short-term liquidity need for one property can be compensated with reserves from other properties. On the other hand, I hold liquid securities in the six-figure range, so I could cover even immensely high short-term expenses. And if that’s still not enough, I am convinced that within 1 month I can find a buyer for centrally located properties at a reasonable price (probably not the maximum achievable, but a reasonable one).


:
So this calculation is not clear to most people (recently also to you), at least they were not aware of it before I talked to them about it, they then always are amazed how you can actually get into completely different return regions compared to stocks and the like. But I’m glad that I could at least help one person further.

Regarding the 30-40 sqm:
These were not related to the previous example, but rather to what I am aiming for. I also do not want to buy a property for €500,000 or take out a loan of that amount.
Imagine an apartment with 100 sqm. The calculation remains the same, then it is not an exorbitant rent.
What I wanted to illustrate with the 30-40 sqm is that due to the low building share, the absolute amount for the share of general house repairs on an absolute basis is comparatively low. By the way, in Munich you sometimes have to pay more than €2,000 rent for 30 sqm apartments. Whether that is a lot or little or called exorbitant is irrelevant to me. What matters is the market price for comparable properties and I usually offer the apartments slightly below the market level, which increases the likelihood of quickly finding a tenant (thus less vacancy) and also usually leads to a more relaxed relationship with the tenant afterwards who doesn’t immediately, for example, demand a rent reduction of a few thousand € due to any short-term disturbance. So whether a rent is high or exorbitant is not a question of the absolute amount but always a question of the comparison basis, and then a 30 sqm apartment in Munich for €2,000 can very well be cheap.

So in Frankfurt am Main, there are some apartments in the range of 30-40 sqm for €250,000 – 300,000. You can expect about €700-1,000 rent. I saw one with 35 sqm for €260,000, for example.


:

Although you don’t explicitly cover the tax aspect extensively, it is already included in this rough calculation in the form of the 80% net rent, where the proportional tax is already considered. For me, it was usually the case that on average I only had marginal taxes and often even a negative yield when a lot had to be repaired or there was vacancy. Especially at purchase, a fairly high negative tax yield results, which leads to a lower average tax burden. And the good thing about properties with comparatively low rental yields is that hardly any taxes are incurred due to the construction.

I have to disagree with you firmly for the first time:
For the equity return, the real estate price development must of course also be considered. It would be like only considering dividends with stocks but no price increases (so Amazon would have had a performance of 0% according to that?). In open-ended real estate funds, valuation changes resulting from real estate price increases/decreases are also reflected in the price.
In the case of owner-occupied property, it makes little sense to consider the price development (unless you want to move and then sell), but for rental properties the price development is always included in the equity return and not only at the actual sale, but the book values are already recorded beforehand. (Take a look at the balance sheets of Vonovia, Deutsche Wohnen, etc.).

Of course, real estate prices can fall. But that is possible with any investment, that something can go wrong/fall. That is nothing specific to real estate.
Roughly:
In the long run, real estate prices tend to rise because due to inflation the construction of new buildings becomes more expensive and the gap between old and new builds does not completely diverge, otherwise everyone would only buy old buildings and no new buildings (so old buildings also increase in price). The price development of a specific property is then overlaid by the specific supply and demand situation. That means how employment situation develops or population numbers and how many new buildings etc. In this area, you naturally have to do your homework thoroughly before investing. I even drove routes during rush hours on vacation near potential objects to employment centers / tested public transport etc.
Whether prices in Düsseldorf fall a bit in a year or not plays a rather minor role for me. The medium-term perspective is decisive for me and I still see Düsseldorf as interesting. If you talk to people living in NRW about where they would most like to live in NRW, Düsseldorf usually comes up, so prices probably won’t fall to abyssal levels there. Usually, when real estate prices stagnate/weaken somewhat, rental yields increase again a bit. And even after a severe crisis, it usually goes uphill again. In America, house prices are almost back to pre-crisis levels.
Yes, of course there are renovation costs. They are all included. I even had tenants who just wanted to move into the apartment without any walls having to be freshly painted or anything else redone. For every building element of a property, there are certain empirical values as to when it has to be replaced (e.g., facade every 20 years).
I don’t understand this point.

I have already written repeatedly: In principle, I assume that purchase prices should continue rising considerably in the next 2-3 years. Then we should get somewhat higher key interest rates again and thus credit demand will decline, but rental demand in city centers will pick up again. Therefore, I do not worry about such a development but would even welcome it, as the liquidity situation would improve significantly through higher rents.
But I agree that we are now rather at the end of a longer-term price increase.
As already mentioned, in really sought-after locations a property can be sold again quite quickly at fairly decent prices. (Of course not for all and certainly not for those greenfield properties).

For the first time, I have to strongly disagree with you: Of course, the development of real estate prices must also be taken into account for return on equity. That would be like considering only the dividend for stocks but not price increases (so Amazon would have brought a performance of 0% accordingly?). In open real estate funds, valuation changes resulting from real estate price increases/decreases are also reflected in the price. For owner-occupied property, it makes little sense to consider price development (unless you want to move and then sell), but for rental properties, the price development is always taken into account for the return on equity, and not only at actual sale but the book values are recorded beforehand (just look at the balance sheets of Vonovia, Deutsche Wohnen, etc.).

If you had as much knowledge as you write, then the following questions arise for me: - why do you even ask here in the forum if you are so great and can already calculate your return in your head (which one actually—the real one you feel in your wallet or the one dreamed of for the next 20 years)? - are you only rich on paper or in reality? You only have a return in real life if you convert "paper return" into real money at some point Sorry, I have lost interest in your posts by now.

What is partially posted here (both in content and style) is simply terrible. It’s quite funny what some people here try to tell me about real estate investments, who apparently don’t know much about it.
Just this much: I have been active in the real estate sector for well over 10 years. My personal "balance sheet total" / loan volume is well into the seven-figure range. (I also own other financed properties that I haven’t mentioned in the other thread yet, because otherwise that thread would have been full of those destructive hater comments like HelpHelp etc. from the start).
The fact is that the simulations I made (much more extensive than posted here) did not quite correspond to reality. Because for me reality looks - even if many here apparently cannot accept or want to believe it - significantly rosier than roughly estimated in the example, since the actual real estate price development was drastically above 4%. Specifically, for example, about 10 years ago I bought a property that has now approximately doubled in value. (And when I took out the loans, the rental yield was generally still over 4%. (That is no longer the case now, of course).

Very clear for everyone:
The example is not an exact yield calculation for a property I am about to buy now, but rather was intended to roughly show user Tassimat how equity returns of around 20% come about. The actual situation AT THE MOMENT is more like rental yields are lower, but expected price increases are higher.

@ ghost:
All operating costs are already included in this rough calculation. Apparently, you did not read my post properly. If you buy 100 m2, of course 80% won’t work anymore.
What kind of Excel calculators should I build??? Calculating a rental yield should be doable in your head, and if you can’t manage that, you can use a calculator. You need to know what the property costs (including ancillary costs), how high the roughly expected gross rent is. From that you can then derive the desired loan payment amount (or repayment rate) that you have to tell the bank. You don’t need to look at more numbers initially.

But this number calculation is also not the decisive factor in real estate investments, although most people always waste their time on it and then calculate m2 prices or something similar and consider themselves great investors if they have once calculated a rental yield. Much more important is to study the "soft skills" (as I call them). That means connection to public transport/traffic jams, proximity to shopping centers, traffic noise etc. etc. — in short location, location, location — (potential future) renovation costs depending on used building materials, etc., and above all studying demographic development. That is the hard and very time-consuming work in real estate investments, not these trivial overall number calculations in a quiet room where you calculate a theoretical rental yield or whatever, because these calculations won’t help you if you don’t manage to rent out the property properly or if unexpected renovation costs come up etc.

@ chand:
The general basic goal should be:
Maximizing returns under the mandatory condition that liquidity is continuously ensured. It is suboptimal to always have very high liquidity but only low returns.
My financings are roughly cash-flow neutral. Whether I have to add a few thousand liquidity in a year plays a minor role. On the one hand, the more properties you have, the variance of rental defaults, high repair costs, etc. decreases strongly on the overall portfolio level; that is, a short-term liquidity requirement for one property can be compensated with reserves from other properties. On the other hand, I hold liquid securities in the six-figure range, so I could cover very high short-term expenses. And if all that is not enough, I am convinced I could find a buyer within 1 month for centrally located properties at a reasonable price (although probably not the maximum achievable, but a reasonable one).

:
So this calculation is not clear to most people (recently also to you), (at least they were not aware of it before I spoke to them about it), and they are always amazed how you can actually come to completely different return regions compared to stocks and the like. But I’m glad that I could at least help one person.

Regarding the 30-40 m2:
They were not related to the previous example but rather to what I am aiming for. I do not want to buy a property for €500,000 or take out a loan of that amount.
Imagine an apartment with 100 m2. The calculation remains the same; then it is not an exorbitant rent.
What I wanted to illustrate with the 30-40 m2 is that due to the low building share, the absolute amount for the share in general house repairs is comparatively low on an absolute basis. By the way, in Munich you sometimes have to pay over €2,000 rent for 30 m2 apartments. Whether that is much or little or is called exorbitant does not matter to me. What’s decisive for me is what the market price is for comparable objects, and I then generally offer the apartments a little below the market level, which increases the likelihood of quickly finding a tenant (i.e., less vacancy) and also tends to result in a more relaxed relationship with the tenant, so that they do not immediately, for example, demand a rent reduction of a few thousand € because of every short-term disturbance. So whether a rent is high or exorbitant is not a question of absolute amount but always a question of the comparison basis, and then, for example, a 30 m2 apartment in Munich for €2,000 can be cheap.

So in Frankfurt am Main, there are some apartments in the 30-40 m2 range for €250,000-300,000. You can expect about €700-1,000 rent. I saw one, for example, with 35 m2 at €260,000.

:

Although you do not explicitly show the tax consideration in full breadth, it is already included in this rough calculation in the form of the 80% net rent, where the proportional tax is already taken into account. For me, it was usually the case that I had only marginal taxes on average and often even a negative return if there was a lot to repair or there was vacancy. Especially at purchase, a fairly high negative tax effect occurs, which then leads to a lower average tax burden. And the good thing with properties with comparatively low rental yields is that hardly any taxes arise due to their construction.

I have to strongly disagree with you for the first time:
The equity return must of course also take into account the property price development. That would be like only considering dividends with stocks but no price increases (so Amazon would have had a performance of 0%?). In open-ended real estate funds, valuation changes resulting from real estate price increases/decreases are also reflected in the price.
For owner-occupied properties, it makes little sense to consider price development (unless you want to move and then sell), but for rental properties, the price development is always taken into account for the equity return, and not only at actual sale but book values are also recorded beforehand. (Look at the balance sheets of Vonovia, Deutsche Wohnen, etc.).

Of course, property prices can fall. But that is possible for every investment, that something can go wrong/fall. That is nothing specific or a special problem for real estate.
Roughly:
In the long run, real estate prices tend to rise because due to inflation, the construction of new buildings becomes more expensive and the gap between old and new buildings does not widen completely, otherwise everyone would buy only old buildings and no new ones (so old buildings also increase in price). The price development of a specific property is then overlaid by the specific supply and demand situation. That means how employment situation or population number develops and how many new buildings are built, etc. In that area, you have to do your homework thoroughly before you invest. I even drove potential routes to employment centers during rush hour on vacation / tested public transport etc.
Whether prices in Düsseldorf fall a little in one year or not plays a rather minor role for me. The medium-term perspective is decisive for me, and I still see Düsseldorf as interesting. When you talk to people living in NRW about where they would most like to live, it’s usually Düsseldorf, so prices there will not fall into the abyss. Usually it is also the case that at the moment real estate prices stagnate or weaken a bit, rental yields pick up a bit again. And even after a severe crisis, things usually pick up again. In America, house prices are almost back to pre-crisis levels.
Yes, there are renovation costs. They are all taken into account. I had tenants who wanted to move into the apartment just like that without any walls being repainted or anything else done. For every building component of a property, there are certain empirical values as to when they need to be replaced (e.g., facade every 20 years).
I don’t understand that point.

I have repeatedly written: As a basic principle, I assume that purchase prices should continue to rise quite significantly in the next 2-3 years. Then we should get somewhat higher key interest rates again, and credit demand will decrease, but rental demand in centers will increase again. In this respect, I do not see such a development worriedly but would even support it, as the liquidity situation improves significantly through higher rents.
But I do agree that we are already rather at the end of a longer-term price increase now.
As written already, in the really sought-after locations, you can also liquidate a property again quite quickly at quite decent prices. (Of course, this does not apply to all and certainly not to those greenfield properties.

Then I don’t understand your pity thread. I only have €1,500 income and get no financing. If you were a real estate mogul as you say, 1 the savings bank director would issue a blank loan, 2 you wouldn’t need financing at all because you pay everything from free cash flow. Sorry, for me you are an internet troll.

:
Your first question is very easy to answer, but your second question is much more complex.
Why I am posting here, I answered in the other thread. One topic area (internal bank KDF guidelines) has (almost) nothing to do with the other (which repayment rate, which term, which property, how an equity return is calculated, etc.).

First of all:
I do not calculate equity return in my head (of course I can't); I do not calculate it at all anymore. The calculation mentioned at the beginning I ran through in numerous variations before my first investments (sometimes more equity input, sometimes less, sometimes higher rent, sometimes lower, sometimes more appreciation, sometimes less, sometimes more repayment, sometimes less, etc. and combinations thereof). Even with relatively unfavorable assumptions, the equity return (with a high proportion of debt) was still significantly above the expected return of conventional asset classes such as stocks, bonds, equity-financed real estate, gold, etc.). Assuming this basic knowledge, it’s only a matter of deciding in which specific property to invest.
In my head I calculate – if at all – simple rental yields, and the only real calculation I currently make is: calculate 80% of the expected target rent (I do that in my head). That should roughly correspond to the amount of the loan installments with the bank. I don’t calculate more, why should I? Initially, it does not matter to me whether a (theoretical) equity return of 18.7% or 21.3% comes out in an investment. I can’t actively influence the value appreciation (I have to focus on what I can influence). I must sufficiently estimate the appreciation in advance from various properties and for that, the described “soft skills” are necessary, such as population growth vs. newly built properties, etc. (I admit I underestimated appreciation in the past, i.e., I had assumed too low an appreciation). That’s where the performance is made, but not in comparison of (theoretical) rental yields. To be precise: it is about comparing equity returns, but for that you need appreciation as an input parameter, and what I say is: a model can only be as good as its input parameters allow, so I prefer to focus primarily on the input parameters themselves rather than on a (although basically correct) model that then again delivers an unsatisfactory result due to incorrectly estimated input parameters and resulting follow-up errors.
So I prefer a central, renovated apartment on the top floor facing south, connected to public transport, traffic-calmed, with a 3.6% rental yield rather than a renovation-needy apartment with a 5.2% rental yield on the ground floor on a main street, far from the nearest subway/train station. I know investors who then buy properties with rental yields of 7%, but later wonder why they can’t find tenants, why a mold remediation is pending, etc. Over time you also get a feeling for which property is interesting now and which is less, without having calculated anything at all.

Now for the actually more exciting question, to what extent I am rich in reality or on paper. I can't really answer this because I don’t know what “in reality” exactly means to you. Is Trump rich in reality or only on paper, considering his billions in loans?
So I’m not a multimillionaire with 10 million economic equity available. It is true that I don’t have a completely carefree financial life, but I also don’t want to complain about my overall financial situation. I am basically in the capital accumulation phase.
Let’s assume I won 1 million € in the lottery. Then I would probably be rich in reality according to your definition. But I wouldn’t keep that million all the time in a suitcase; I would somehow invest it to earn returns, so I wouldn’t be rich in reality anymore. Looking at the portfolios of the (super) rich, there is about a 40% allocation to stocks, 30% real estate, 10% bonds, 10% gold, 5% small vegetables (such as art, jewelry, wine, cryptocurrencies, etc.), plus 5% liquidity. So are they rich in reality? In an economic crisis, far more than half of the portfolio can suffer a total loss. I have my equity mainly invested in real estate (far more than average), but this has another background besides equity return, to which I will come shortly. Sure, there have been or can be punitive taxes on real estate in crisis situations, but such can occur on almost all other asset classes as well. Real estate has, for example compared to stocks, a higher value stability. People always need somewhere to live (there’s not enough space under the bridge for everyone), whereas you certainly don’t need a company like Facebook to survive.

Now another point comes into play that is decisive from my point of view: one has to distinguish between two asset classes again: on the one hand equity-financed real estate and on the other hand debt-financed real estate. Most people always assume this is similar investment. This is completely wrong. The reason is the wrong perspective. Most people think on an absolute basis, i.e., “I earn so many €, now I get a salary increase of x € and I get 4% interest in the bank.” What they usually do not sufficiently consider is inflation. Fact is: the average net wage increase is below the inflation rate, i.e., people become poorer over time just by working, which makes capital investment necessary. Now consider someone who bought a property purely from own money and rents it out. Let’s say he gets 6% rental yield in his village, the value does not increase (stays the same), there are often vacancies so that the actual yield is about 4%, now renovations costing about 1%, plus non-recoverable ancillary costs, taxes, and much more, so that effectively about 2% rental yield remain. With an inflation rate of 2%, he would just about maintain his value. Most real estate investors are in a similar situation (many even suffer real economic losses). The fact that debt-financed real estate still yields a significant return even after inflation does not need further explanation. What is decisive in this context is: you don’t need protection for a small crisis/recession, but it is important to be prepared for severe economic crises like the late 1920s or the last oil crisis. There it is usually the case that a reduced economic output is combined with strong inflation. In these hyperinflation phases, stock prices gain value, but on a real economic basis they do not offer real inflation protection because inflation rises much faster than stock prices (which is equivalent to a real economic total loss). Fully equity-financed properties can also relatively lose value, but here is the decisive difference between equity and debt-financed properties: with debt-financed properties, the loan taken (at fixed interest rates) is almost worthless in real terms during hyperinflation phases and can be repaid very quickly, and then you have paid-off properties, whereas, for example, those always recommended cash reserves in a safe would then be almost worthless. Clearly, such hyperinflation is an extreme example, but it illustrates the principle.

I resist the commonly stated claim from a bank deposit guarantee fund perspective that “risk-free” overnight money accounts at banks are really safe. They might be safe from the guarantee point of view, i.e., you get your money if the bank goes bankrupt, but these investments are actually highly speculative because investors implicitly speculate on deflation (or at least monetary stability), where money becomes worth more in real terms, as most recently in Japan. Then they would profit from this type of investment in real terms (although interest rates are accordingly low). The fact is that in the last 100 years there was almost always inflation and only very few real deflation phases. Debt-financed real estate investments at fixed interest rates are a speculation on inflation. Admittedly, if there is strong deflation, debt-based real estate investments at fixed interest rates lose real economic value. Debt-financed real estate investments are not risk-free, that’s true; but history has clearly shown that inflation is much more likely than deflation; and I take on the risk of deflation. I consider a deflation scenario unlikely, since central banks target about 2% inflation. Moreover, most states are so exorbitantly in debt that controlling debt service seems only possible with politically desired inflation, i.e., debts can be inflated away.

Conclusion:
It is always a matter of perspective what one considers risk. As I said, I see cash (overnight money, AAA bonds) as an extremely risky asset class, but debt-financed real estate has a certain protective character against inflation (more precisely: a leverage on inflation), and besides gold, which roughly follows inflation 1:1 in the long term, I know no asset class that manages this as well as debt-financed real estate. Debt-based real estate benefits from inflation.
So especially as a defensive investor you should have a certain share of debt-financed real estate. But of course, from a diversification standpoint, you should also invest in other asset classes. This is always a question of personal assessment of how the economy will develop and how you position yourself. (In real economic terms) I don’t know any completely risk-free investments (including money in a sock). It always depends, for example, on the assessment whether we get inflation or deflation; there is no investment that is value-stable in all scenarios (even gold loses value in deflation phases).
Therefore, it is not clear to me how one can be “rich in reality” at all?
Besides liquid securities in the stock and bond area, I also have some gold and, since I am interested in art, some valuable objects in that area. Overall, debt-financed real estate dominates my portfolio, I plan to reduce the debt share somewhat medium-term through sales and not to finance to the limit anymore, but I don’t have enough equity to afford to do without financing entirely.
I hope I have answered your question with this.

@ HilfeHilfe:
Besides your repeated massive articulation problems:
I have approximately CASH-FLOW-NEUTRAL financings! So I have no additional rental income that would exceed the loan payments after operating costs and would suffice up to the hypothetical 6% annuity.