Calculation of profitability and return on investment in real estate

Stability, guarantees, durability, without investing time and effort – all this best characterizes passive income from renting out an apartment. But what is it, this income? How much will you receive and how quickly will the square meters pay off? Is it really profitable to buy real estate for rent? 

We could say that you won't know until you try. But THE Capital doesn't make empty promises and doesn't waste words, so instead of empty assurances of a happy future, we suggest you calculate the real profitability of an apartment.

Step-by-step instructions for calculating profit

We would like to warn you right away that calculations can only approximately reflect reality. This is not because our mathematical abilities are lame, but because of more serious factors. No matter how far into the future you try to look, you can only do it based on the current situation. Life does not take into account your desire for stability and can sometimes turn in a completely unpredictable direction. Speaking of the real estate market, it is worth understanding that it is influenced by many factors. among which are the political and economic situation, seasonality, fluctuations in supply and demand, and now taxes and maintenance costs. It will not be possible to predict the fate of your apartment with an accuracy of hryvnia of its rental value. Therefore, calculating the profitability of the rental gives only an approximate understanding of how profitable it will be to purchase square meters.

Formula for calculating rental income and payback

The financial model of a rental business is built on two key metrics: net profit and payback.

• Net profit = (Total rental income – Operating expenses).
• ROI (return on investment) = (Net profit ÷ Cost of the object) × 100%.

ROI shows the efficiency of the investment in percentage. In international practice, it is believed that 5–7% per annum is an acceptable indicator for stable markets, while in countries with higher risks, investors focus on 8–12%. Inflation processes are not included in the basic formula. They are taken into account indirectly - by revising the rental rate. It is the regular adjustment of the rental price that allows maintaining the actual profitability at a stable level.

How to determine the best rental price

Optimal rental rate is formed on the balance of supply and demand. The owner should analyze current offers on the apartment rental market, pay attention to the condition of similar apartments and the average speed of their completion.

An overpriced property often leads to downtime, which reduces annual revenue. An underpriced property leads to lost profits, when the property is sold quickly but the financial return is lower than the potential. Successful investors constantly analyze the market and keep their rates within a range that ensures stable occupancy without losing margin.

What costs should be considered when renting out real estate?

A common mistake investors make is to evaluate profitability based solely on rental income. Instead, the financial model should take into account the full range of costs:

• taxes on rental income;
• utility bills (if they are included in the rental price);
• agency management or commission costs;
• property insurance;
• repair and depreciation of furniture and equipment;

Additionally, it is worth setting aside a reserve for unexpected expenses, such as emergency breakdowns, equipment replacement, and downtime, as the search for new tenants may take longer than expected. For premium segment properties, marketing budgets and management company commissions are also added to this list. 

Example of calculating the yield from renting out real estate

Let's imagine that you are already with our help bought an apartment in the Pechersk district. It is considered one of the most prestigious in the capital, so the prices here are appropriate. Your one-bedroom beauty cost $185,000. Of course, we are talking about an object in a top residential complex and with author's renovation. You can afford to rent out a similar property for $1,200, as our clients already do. Let's say you spend $600 a year on some minor improvements to your property. Now we know all the basic amounts and can start the calculations:

• annual rental income - $1,200 × 12 = $14,400;
• expenses – $600;
• net profit from surrender – $14,400 - $600 = $13,800;
• rental income - ($13,800 / $185,000) × 100% = 7,5%

The result shows that in a year, by renting, you will be able to return 7,5% of the amount you invested in buying a home. However, you should also consider the risks and additional costs that may affect the final result: 

• Subjects: 18% personal income tax + 1,5% military duty = 19,5% of income, that is $2,808;
• Rental management agency services (usually 10% of income) = $1,440;
• Property insurance = approximately $250 per year;
• Current minor repairs and depreciation of equipment = $600;
• Emergency breakdowns and unforeseen expenses (reserve) = $400.

The total cost is about $5,500. So, the real return is about 4,8% per annum, and the payback period is more than 20 years. This is lower than the idealized figure of 7,5%, calculated without taking into account costs. And the difference clearly shows why an investor should lay out all possible costs and risks before making a decision.

How to calculate profitability from daily rental housing

The profitability of daily rentals is calculated using the same formula as for long-term rentals: gross income minus expenses. However, the key difference is in the structure of income and expenses. There are nuances that need to be taken into account: 

• OccupancyIf the average cost per night is $70, but the apartment is occupied 20 days out of 30, the actual monthly income will not be $2,100, but $1,400.
• Service costsThese include cleaning after each guest, laundry, concierge or management services. On average, this is 15–20% of revenue.
• Marketing and platformsAccommodation on Airbnb or Booking.com involves a commission of 10–15%.
• Repair and depreciation costsDaily rentals wear out furniture and appliances faster, so the reserve for renovation should be higher.
• SubjectsIn Ukraine, they are paid at the general rate, as with long-term leases: 18% personal income tax + 1,5% military levy.

As a result, the profitability of daily rentals often looks higher on paper (up to 10–12% per annum), but in reality, due to downtime, platform fees, and increased operating costs, it is closer to 4–5%. The main advantage of this format is greater flexibility in reviewing prices and the ability to earn more during the high season.

Factors affecting profitability

The profitability of a rental business is not determined only by the price of the apartment and the rental rate. The final result is influenced by a number of factors - from the location to the service you offer to the tenant.

Factor 1. Location
Housing in central areas or near business clusters and transport hubs always seems more expensive and faster.

How to increase profitability: Focus on areas with high demand among tenants (central districts, new business zones, housing near the metro or universities).

Factor 2. Housing condition and repairs
Modern design, high-quality appliances and furniture increase the average rate by 15–20%. Old housing stock without renovation is unlikely to bring a normal income.

How to increase profitability: invest in an updated interior, add low-energy appliances, and set up work-from-home areas.

Factor 3. Target audience
A young family, a student, or a foreign specialist are willing to pay different amounts of money for different conditions - take this into account when furnishing your home.

How to increase profitability: adapt the apartment to a specific segment: for example, allow pets, install a cot, or set up a workplace for remote work.

Factor 4. Level of service and management
The faster a tenant’s problems are resolved, the longer they stay. Remote management without service reduces loyalty and increases the risk of downtime.

How to increase profitability: connect a professional management company, automate payments and communication, and ensure prompt resolution of household issues.

Factor 5. Currency and macroeconomic risks
Currency fluctuations and inflation directly affect real returns.

How to increase profitability: Focus on long-term contracts in foreign currency or establish a mechanism for annual review of rent taking into account inflation - and be sure to specify this in the contract.

The most profitable real estate

When choosing a property to invest in, it is important to understand which options will yield the highest return on investment. For example, the number of rooms is an important criterion. One-room apartments traditionally show the highest profitability in relation to the invested funds. They have the greatest demand among tenants (young professionals, students, small families) and a lower purchase price, which gives a better percentage of return on investment. At the same time, 2-room apartments are the best option for those looking for a balance between profitability and stability. They attract families and provide a stable flow of tenants.

Proximity to the metro is one of the most important criteria. Apartments within a 5-10 minute walk from a metro station are 20-30% more expensive to rent and find tenants faster, especially in Kyiv. Central areas provide high rents, but the purchase price is also significantly higher. 

The condition and type of building are important. New buildings with turnkey renovations allow you to immediately rent out an apartment at a higher price without additional investments. They attract solvent tenants and require minimal maintenance costs in the first years. Secondary housing after high-quality renovation can show even higher profitability due to a lower purchase price, although it requires initial investment in renovation.

There are other factors that affect the profitability of the facility:

• Availability of furniture and appliances — increases the rent by 15-25%;
• Separate planning valued more than adjoining rooms;
• Availability of a balcony/loggia adds 5-10% to the rental cost;
• Parking (especially underground) - important for the premium segment;
• Concierge and security in new buildings increase attractiveness.

In general, a one-room or two-room apartment in a new building or after a high-quality renovation, near the metro (in a residential area with infrastructure or on the border with the center) usually provides the optimal ratio of purchase price to rental income.

When investing in real estate may be unprofitable

Not every real estate investment is profitable. It is important to be able to recognize situations when an investment does not meet expectations and know how to correct the situation. For example, when the profitability is less than 3% per annum. This is an alarming signal to review the investment strategy. With such profitability:

• Payback period exceeds 30 years — your funds will take too long to be returned;
• Inflation eats away at profits — real return can be zero or even negative;
• Alternative investments are more profitable — deposits, bonds or other instruments can bring higher income with lower risks;
• Maintenance costs are rising — utility bills, repairs, and taxes may exceed profits.

Buying an expensive apartment in a prestigious area where the rent does not compensate for the high cost of the object is also not the best solution. For example, housing in the center can cost $150,000 and be rented for $600/month, while an apartment for $60,000 in a residential area is rented for $300/month. Also, apartments on the first floors without renovation, or in buildings without an elevator on high floors, or with a poor layout, etc., are difficult to rent and bring low income.

New business-class buildings with high utility bills, mandatory maintenance fees, and expensive maintenance can reduce rental income by up to 30-40%.

However, if the apartment has already been purchased but is showing low profitability, there are several ways to rectify the situation. For example, make cosmetic repairs and update the furnishings. You can also consider changing the target audience or rental format. Of course, one of the most effective ways is to entrust managing your property to specialists who will independently find tenants, reduce the downtime (which will pay off the commission), and generally take care of all the hassle. 

If all methods of increasing profitability have been exhausted, and the profitability of renting an apartment remains below 4-5%, it is worth considering selling the property and buying a profitable optionSometimes admitting a mistake and reinvesting funds is the smartest decision.

Visnovok

Rental profitability is not dry math. ROI and payback period formulas provide a basic understanding of investment efficiency, but the real value for an investor lies in the ability to see the bigger picture. Profit depends not only on the amount of rental income, but also on the full range of expenses: taxes, insurance, agency fees, downtime or even emergency repairs. Therefore, the financial model should be as realistic as possible - it is better to leave optimism for everyday life.

Practice shows that a high rental rate does not always equal high profitability. The optimal option is flexible pricing and regular analysis of analogues in a particular area. The rental format is no less important: daily rental looks attractive on paper, but real profitability is often equal to long-term due to commissions and service costs.

For the investor, the key to stable profitability investment in real estate becomes a strategy. A competent choice of location, thoughtful arrangement of housing, work with the target audience and a mechanism for indexing rent. And in the end, a properly selected and managed object becomes a stable source of annual income and a tool for preserving capital for years to come.