By Indhira Desangles
Special for El Inmobiliario
Lately I have been asked about the meaning of the rental profitability percentage that is being used on various real estate websites, so I will start by clarifying the meaning of these percentages.
Let's imagine you enter a website and it says: Profitability values of 15%. What does that figure mean? Simple: that for every one hundred dollars invested, you receive fifteen dollars of profit.
However, you have to be very careful with those calculations to ensure you have the correct percentage, because, after all, we're talking about profits.
The way I recommend calculating it is through the calculation of the Net Present Value (NPV), since it is the result of the calculation of the update of future cash flows (the monthly rents) originated by an investment (the purchase of the premises).
In fact, did you know that in the context of corporate valuation, this was the method used by Warren Buffett to evaluate his investments?
Therefore, I will allow myself to be a little technical so that we can ultimately arrive together at the correct interpretation of the numbers, and when we see percentages on portals, we can evaluate whether the value is indeed correct or not.
Below, I share the formula to use: In that formula:
Initial investment: This is the value of the initial investment (for example, the purchase price)
Cash flow: is the value of the cash flow in each period
t: the value of the monthly rent
n: is the number of periods considered (number of months, for this example)
i: is the interest rate
Here's a practical example:
Let's assume we've purchased a commercial property for $100,000 and, based on its characteristics, we've concluded that we could rent it out for $1,000 per month. What is its profitability?
This is when we use the NPV formula, setting it equal to 0, and introducing initial value = $100,000 t = 12,000 (we take this value as a constant annual value for this example) yn = 10 (we will study its profitability over 10 years), obtaining that its profitability is almost 3.5% (k = 3.46%).
This means that by obtaining a positive value, the projected profits exceed the costs, so it is assumed that whenever an NPV is positive, the investment will be profitable.
The author is:
Specialist in commercial and corporate real estate, real estate advisor with nearly 20 years of experience.
Acropolis Corporate Center, Spatium, 8th Floor, Piantini, Santo Domingo. Dominican Republic, 10127.
+1(809) 669 3063
Desangles.Properties.
