However, Ugnius Latvys, the head and one of the partners of the real estate development company “KAITA Group,” which manages nearly 1000 rental properties in European capitals, points out that when calculating future returns, buyers often consider rent but forget another equally important part of the investment – to whom and for how much this property will be sold after ten years or more.
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Almost nine out of ten Lithuanian residents live in their own homes, so real estate (RE) is more familiar to many than stocks, bonds, or fund units. Long-term market trends have also been favorable for property owners. Over the past fifteen years, rental prices in Lithuania have increased by more than 177%, one of the largest changes in the European Union. Across the EU, rent increased by an average of 25% over the same period.
However, according to U. Latvys, historically rising prices can create the illusion of an overly simple investment model for less experienced investors: buy an apartment, find a tenant, and wait for the property itself to appreciate.
“Rental yield is an important indicator, but it only shows one part of the investment. The final result becomes clear when all income received, expenses incurred, and the amount for which the property is sold are calculated. Sometimes a difference of several thousand euros at the time of sale can wipe out rental income accumulated over several years,” says the head of “KAITA Group.”
An often forgotten important stage
According to the expert, an investment in a rental property can be divided into three stages.
“The first is acquisition. Here, the price of the apartment, the initial down payment, loan conditions, property appraisal, notary, furnishing, and other initial expenses are important. The second is renting out the property. The owner receives income but also looks for tenants, manages contracts and payments, fixes malfunctions, updates equipment, and faces periods when the property remains vacant. The third is sale. Only then does it become clear how much capital accumulated in the property was recovered and what the return over the entire investment period was,” says U. Latvys.
Most attention, he says, is usually given to the second stage because monthly rent is the most visible part of the investment. And the future sale is often based on the general assumption that real estate appreciates over time and a buyer will appear anyway.
“Even before purchasing a property, it is worth asking yourself what you will sell one day. Is it just an apartment of a certain size at a specific address, or an already operating investment whose income and expenses can be shown with numbers? These are not the same offers, although physically the same property is being sold,” notes the head of “KAITA Group.”
How to calculate rental return?
When choosing a property for investment, the easiest figure to calculate is the pre-tax yield. For example, if a property together with furnishing costs 150 thousand euros and is expected to be rented out for 750 euros per month, the annual rental income would be 9 thousand euros. Dividing this by the invested amount gives a 6% pre-tax yield.
“It is important to calculate realistically: the property may remain vacant for at least one month per year, and part of the income will need to be allocated for administration, insurance, minor repairs, and future furniture and equipment updates. Then, from the theoretical 9 thousand euros before financing costs and taxes, for example, 6.5-7 thousand euros may remain. The actual property yield in this case would no longer be 6%, but about 4.3-4.7%.
If the property was purchased with a loan, another calculation is needed: to assess how much income remains after paying interest. The property value may increase, but the investor may still have to pay extra from other income every month,” explains U. Latvys.
What will you sell in the long run?
After ten or fifteen years, the apartment may need to be sold, and according to U. Latvys, there are usually several reasons for this: the investor sees an opportunity for another investment or needs money due to a changed life situation. The expert emphasizes that it is important to think about this already when buying a property for investment.
“Two similar investment apartments may be rented for the same 800 euros per month, but that does not mean they earn equally. In one, tenants may change every six months, the property may stand without income for several weeks between contracts, and part of the rent must be spent on repairs. The other may be stably occupied and require much less expense.
Therefore, several years of income, occupancy, and expense history create added value for the future buyer: it allows paying for an actually operating cash flow, not for the seller’s forecast. The fewer unknowns the new owner has to take on, the more successfully the property will be sold,” says the head of “KAITA Group.”
According to him, the property’s income history should not be understood only as the rental contract valid at the time of sale. One tenant may pay more or less than is usual in the market at that time, and their contract may soon expire.
“Much more is told by several years of results: actual occupancy, rent actually collected, tenant turnover, periods without income, and property maintenance costs,” says U. Latvys.
What does the income history tell the buyer?
The price of a residential property is primarily determined by similar transactions: how much a square meter costs in the same district, building, or a project of similar quality. However, according to the expert, the investor also evaluates the income generated by the property alongside these.
“Suppose, after usual property operating expenses, the property generates 7.2 thousand euros of income per year before loan costs and taxes. If the buyer expects a 5.5% net yield from such an investment, according to the simple income capitalization principle, such a cash flow would correspond to a property value of about 131 thousand euros. If, due to increased interest rates, higher market risk, or more attractive alternatives, the buyer expects a 6.5% yield, the same 7.2 thousand euros cash flow would correspond to a value of about 111 thousand euros,” says the head of “KAITA Group.”
Another common mistake, according to the expert, is choosing a rental property as if the buyer themselves intended to live there. They evaluate whether they like the interior, whether there is enough space for personal belongings, or whether the owner would want such a view from the window.
“A personal and an investment property serve different functions. The first must fit a specific person’s lifestyle. The second must meet the needs of a clearly defined, sufficiently large group of tenants and generate reasonable income. A student, a young specialist, a temporarily relocated employee, a couple, or a family will need different space, location, furnishing, and services. Therefore, a property cannot be evaluated without answering who it is intended for.
A small property can be a very rational investment if its area is functionally planned and there are enough people for whom it is important to conveniently reach work, studies, and city services. Likewise, a larger apartment is not inherently better – if it requires much more capital and rental income increases only slightly, part of the invested funds simply work inefficiently,” explains U. Latvys.
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