Understand how to compare rental income with financial investments – 06/23/2023 – From Grain to Grain

Most landlords misunderstand the income they receive from renting properties. This misinterpretation leads to erroneous comparisons with financial investments and, consequently, failure in the investment decision.

In the building where I live, there are four apartments per floor and a total of 15 floors. Only on my floor there are two vacant apartments for rent. One of these units has been free to rent for at least one year.

I pay BRL 3,500 monthly rent plus condominium fees and taxes that bring my living expenses to BRL 5,000 per month. The value of the property is close to R$ 1.2 million, as it is an old building with no leisure facilities.

I am putting my case and what happens to my neighbors just as an illustration to explain the calculation of rent income.

So let’s go. How much rental income does my property owner receive?
a) 0.41% per month, i.e. 5% per year
a) 0.29% per month, i.e. 3.5% per year
a) 0.20% per month, that is 2.4% per year

The result of the income per year is simply calculated by multiplying the monthly income by 12. Yes, this is a detail that many also confuse. In real estate, there is no compound interest on rental income. You do not reinvest rent in the same property.

Many landlords receive from the tenants all the expenses that I spend on housing and they themselves are responsible for paying the condominium fee, IPTU and insurance. Thus, several of them believe that the rental income is the one presented in item A.

To arrive at alternative A, the landlord divides the receipt of R$ 5 thousand by the value of the property of R$ 1.2 million.

However, only rent is really revenue. Therefore, option A is incorrect.

Maybe you marked alternative B as the correct one. In it, only rent revenue of R$ 3,500 per month is considered as income.

However, anyone who thinks she is entirely yours is mistaken. Therefore, option B is not correct either.

I’ll explain why rent revenue is not all renter’s, using the example of the apartment next to mine.

Why do you think the apartment next door to mine has been empty for a year?

That’s right. Its condition is not the best.

Who do you believe should invest in maintenance, conservation and renovation of the property to make renting easier?

Naively, real estate investors believe that all rental income is theirs. This is not true. You must set aside at least 10% of the rent to renovate the property in order to rent it out faster.

Also, it is necessary to consider the vacancy cost of at least six months every 5 years. This represents a cost of over 10% of the rental amount.

Additionally, a 10% provision must be made for other expenses such as condominium expenses in excess of ordinary expenses, rental and administration expenses and others.

So a more realistic account of your rent income net of provisions would be 70% of rent. Remember, I am not considering taxes.

Therefore, item C would be the correct answer. The income of the owner of the property I rent is close to 0.20% per month.

Perhaps the reader will come to the conclusion that with this calculation the owner should prefer a CDB paying IPCA+6% per year, as he would be earning much more.

After all, 6% per year on top of an investment of R$ 1.2 million would produce revenue equivalent to R$ 6,000 per month. Additionally, the value of this investment would still appreciate with the IPCA.

In addition to the higher yield, a financial application like this considers compound interest, which means that your earnings are much higher than just 2.5% per year accumulated with simple interest.

I agree and that’s why I rent and not buy, but you shouldn’t make this comparison so simple.

It is also necessary to consider the valuation of the property.

Thus, if the owner of my property believes that the apartment will appreciate at least 9% per year, he could prefer the property to the CDB.

I don’t believe in this appreciation of 9% per year. Therefore, my preference is still for the CDB and other fixed income and variable income financial investments, such as real estate funds, to invest in a property. I’m still happy with my decision to live on rent.

Michael Viriato is an investment advisor and founding partner of Investor House.

Talk directly to me via email.

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