Real estate as an investment for beginners: A guide for newcomers
Buy real estate as an investment – So you want to invest in real estate? That’s a great idea! Real estate can be a stable and profitable form of investment. If return and positive cash flow are still foreign words to you, then you’re exactly in the right place. We’ll lift the mystery around the money machine of real estate ownership. In this article, you’ll learn the basics of investing money. Location, return, financing: What really matters? Go back to the guide here: Real Estate as an Investment.
Why invest in real estate?
Real Estate has historically tended to increase in value, making it a stable long-term investment option. Real Estate prices have risen nationwide over the past few years. This is also shown by the current house price index from the Federal Statistical Office, which, starting from the year 2015 (index = 100), reached about 162.9 points in 2022. Thus, prices have increased by 62.9 percent compared to the base year 2015. (Statista, 2023)
The demand for housing often increases over time. Real Estate is therefore a popular choice because it offers long-term benefits. They can generate regular rental income and appreciate in value over time. Real Estate investments also offer tax advantages and a certain level of protection against inflation.
Real Estate as an Investment: The Basics at a Glance
It really matters when you want to invest in an investment.
- The right location (A-, B-, C-location)
- Return of at least 9 % and positive cash flow (profit above cost coverage)
- Long-term financing with 20 % equity & repayment of the loan through rental income
In this article, you’ll learn the most important things about investing and get helpful tips, so you can make a decision right away – invest or not?
The Right Real Estate Choice
Before you invest, you should consider what type of property you want to buy.
- Apartment as an Investment
- House as an Investment
- Commercial Real Estate as an Investment
- Multi-family Homes as an Investment
Reading tip!
Apartments are often easy to rent and attract tenants who want to stay long-term. Single-family homes are also a popular choice and can bring in higher rental income. Commercial real estate includes offices, retail spaces, and industrial buildings. They often offer higher returns, but require more management. Multi-family homes can be a good choice if you want multiple sources of rental income.
Usually, beginners in the real estate sector start with a condominium. Whether it’s a house or an apartment, the location is crucial!
A-, B- & C-Location: The Meaning of Location
Tip: The location of a property is crucial. A good location can lead to higher rental income and increased value. Pay attention to infrastructure, access to schools and shops, as well as the development in the surrounding area.
What do A-, B- and C-locations of a property mean and why is it so important for your investment?
The terms A-location, B-location and C-location are common terms in the real estate world to assess the quality and location of a property. The location of a property is a decisive factor for the success of your investment, as it significantly influences the rental yield, value development and risk.
A-location: high purchase price & low income
A-locations are top-tier locations. They are situated in the best and most sought-after city districts or in immediate proximity to important facilities and amenities such as city centers, shopping centers, schools, and transport links.
Real Estate in A-locations is usually more expensive, but they often offer the highest rental income and the best value appreciation. Demand for housing in A-locations is high, and these locations are less vulnerable to economic fluctuations. With an A-location, you are pursuing a long-term, profitable strategy. Those who are dependent on high rental income in the short term tend to opt for a B- or C-location instead.
B-location: the golden middle
B-locations are in good, but not top-tier areas. They may be somewhat further away from the main urban centers, but they still offer solid connectivity and good quality of life. Real Estate in B-locations is often more affordable than in A-locations, and the rental income is solid. The value appreciation can still be attractive if the area becomes more appealing.
C-location: low purchase price & high income
C-locations are in less desirable areas, usually further away from city centers and important facilities. These locations can sometimes face social and economic challenges. Real estate in C-locations is generally affordable, but rental income is lower. The value growth can be limited, and these locations are more vulnerable to economic fluctuations. The risk with C-locations is higher, although you can make money with C-locations in the short term.
The significance of these locations for your investment lies in the fact that they influence your return and your risk
It is important to consider rental income, value growth, and risk.
Rental Income
Real estate in A-locations often generates higher rental income, which can increase your ongoing return.
Value Growth
A-locations often have the potential for stronger value appreciation over time.
Risk
Real estate in C-locations can be exposed to higher risks, such as vacancies or poor tenants. B-locations often offer a balanced ratio of return and risk.
A-, B- or C-Property?
It is important to consider your investment goals and risk tolerance when buying real estate. If you are looking for stable rental income and long-term appreciation, a B-location could be the best choice. If you want to achieve higher returns and are willing to take on more risk, you might consider investing in A-locations. In any case, it is crucial to thoroughly research the real estate market and the specific location before investing. (Source: Lukinski.de)
Tips for further considerations when choosing real estate can be found in the following articles:
- Rented or Unrented?
- Living space for homeowners and investors
- Construction year and condition of real estate
- Existing properties or new builds?
The return decides: invest or not?
After you have decided on the right property location, you need to ask yourself the two most important questions when buying an investment, in order to evaluate the investment in a property. These questions are:
- How much do I need?
- How much will the property bring me?
This is how you evaluate an investment, let’s get started!
How much do I need?
In principle, this question is very easy to answer with common figures.
You need at least 9 % amortization to cover the costs of the investment.
These consist of 2 % repayment / purchase price, 2 % property maintenance and the current interest rates. The interest rates are currently (as of 2023) at 5 %. So in today’s real estate market, you arrive at a 9 % return, which the property must generate.
How much does the property bring me?
You have not made a profit yet. If the return is above 9 %, you have entered the profit area. This is called positive cash flow, which you cover with the investment not only all associated costs, but also generate additional monthly income. To know exactly how much the investment can bring you, you calculate the gross return. For this, it is important to know the purchase price of the property and the expected rental income. For this, you should compare similar properties and their rents from the surrounding area with your property. How to calculate the gross return is shown in the following example.
Calculating gross return: example
The gross return of an investment is calculated simply by:
Gross return = (Annual rental income / purchase price or market value of the property) * 100
The gross return shows the ratio between the annual rental income and the value of the property in percent. It is a first key figure for assessing profitability.
Here is a simple example to help you understand the calculation:
Suppose you buy a property for 180,000 euros. The annual rental income from this property is 16,500 euros. Then the calculation would look like this:
Gross return = (16,500 / 180,000) * 100 = 9.17 %
In this example, the gross return is 9.17 %. This means that you achieve an annual return of 9.17 % of your invested capital through rental income, before any costs are considered.
Gross return & Net return
The gross return provides only a basic figure that gives you a rough overview of the profitability of an investment. This calculation is a tool for quick decisions. However, the net return is more accurate. Why the net return is more important: The net return is a more comprehensive and precise figure, as it takes into account the actual income and expenses. It includes costs such as taxes, insurance, maintenance, management, and financing costs. Therefore, the net return offers a more realistic picture of the actual return on your investment.
Calculating the net return: Example
As already learned, the net yield of an investment considers all income and expenses, including operating costs, taxes, and financing costs. Here’s a simple example of how to calculate the net yield:
Assume you buy a rental apartment for 200,000 euros. The annual rental income is 15,000 euros. The annual operating costs (such as maintenance, insurance, and management) amount to 3,000 euros. Annual taxes on the rental income are 2,000 euros, and you pay 5,000 euros in interest annually on your mortgage.
The net yield is calculated as follows:
Net yield = ((Annual rental income – Annual operating costs – Annual taxes – Annual interest) / Property purchase price) * 100
Net yield = ((15,000 – 3,000 – 2,000 – 5,000) / 200,000) * 100
Net yield = (5,000 / 200,000) * 100
Net yield = 2.5%
In this example, the net return is 2.5%. This means that you achieve an annual return of 2.5% of your invested capital through rental income, after all costs have been taken into account. The net return therefore provides a more accurate picture of the actual profitability of your investment compared to the gross return, which only considers rental income and the purchase price. (Source: Immobilien-erfahrung.de)
Another important piece of information in the context of buying an investment is the speculation tax: When do I have to pay taxes on my profits?
Speculation tax: Owner-occupied & rental property
An important piece of information for you: The capital gains tax is a tax on profits from the sale of investments such as stocks or real estate, when these are sold within a certain holding period. In simple terms: You pay this tax when you make a profit from an investment. For personal use, this tax becomes due after three years. For rental properties, it is due after 10 years.
For personal use after 3 years
The sale of a self-occupied property is generally tax-free. For full tax exemption, you must have lived in the property for at least two years and must not have already sold it tax-free in the last 10 years.
For rental properties after 10 years
Profits from the sale of rented real estate are subject to capital gains tax. The holding period influences the tax burden. If the property is sold within 10 years of purchase, taxes may become due. The amount of tax depends on the profits made and individual tax rates. (Source: Haufe.de)
Last but not least, financing your investment is the third key factor for the success of your investment. What you need to know now!
Financing your investment
Most of us cannot buy a property in cash. You will probably need a mortgage loan. For this, you should check your creditworthiness and ensure that you can comfortably pay the monthly installments.
The importance of location
The location of a real estate property is crucial. A good location can lead to higher rental income and increased value. Pay attention to infrastructure, access to schools and shops, as well as the development in the surrounding area.
Renting out your real estate
Once you have purchased the property, you need to find tenants. Create attractive advertisements, conduct thorough background checks, and ensure regular maintenance.
Management and maintenance
The maintenance of your real estate is crucial to preserve its value. You must plan for repairs and renovations and ensure that all legal requirements are met.
Tax considerations
Speak with a tax advisor to find out how real estate investments can affect your tax situation. You could benefit from depreciation, tax advantages, and other regulations. More about tax advantages of real estate investments, here:
In the end, the answer to the following question is decisive:
How to finance an investment property in the most sensible way?
When financing an investment with an eye on inflation, it is important to consider long-term strategies. Inflation reduces the purchasing power of money over time, so it is crucial to ensure the long-term value preservation of your capital. Using your own money (equity of at least 20% of the purchase price) to finance the investment is the simplest and risk-free option. It minimizes debt and interest burdens.
Tip: With the mortgage interest rate calculator from Dr. Klein, you can quickly get an initial overview of your potential home financing.
Now you know the basics to get started. Keep in mind that real estate investments require time and commitment, but they can be a rewarding way to build long-term wealth. Good luck on your real estate adventure!
If you want to dive deeper into the world of real estate investment, you’ll find more helpful tips here! Tap into the knowledge of real estate experts and benefit from their experience. All mistakes have already been made by someone else. Inform yourself, and become a true professional in purchasing investments.
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