Loss of rent: yield effect

Vacancies, rent arrears or even re-letting and tenant selection. There is a lot for you to consider when buying real estate. Even if you have found a profitable property in the real estate acquisition process with a good property yield, 2 or 3 months of vacancy per year can make your investment suddenly unprofitable. Why and why is the choice of location / property type so important? You can find out more here in the Real estate purchase risk guide.

This guide is therefore about raising awareness of the topic of location selection and property type. When buying a property, in most cases you are taking over the current tenant. It is therefore important to always check the seller’s tenant history!

Loss of rent = you pay the costs instead of your tenant

Let’s start with the topic of vacancies.

Reasons for vacancies and rent losses

Tenants who don’t want to pay quickly make an investment unprofitable. But it doesn’t always have to be the worst-case scenario – rental nomads are rare – rent defaults can also occur because your tenant has financial difficulties and can no longer pay the rent on time. Or a change of tenant when you move and your new “ideal” tenant only moves in a month or two later.

In addition, there are structural changes, long-term vacancies, when the location becomes unattractive for tenants.

There are therefore many reasons for rent losses:

• Rent not paid – tenant has financial problems
• Vacancy, e.g. for new tenants – “desired” tenant arrives later
• Vacancies due to structural changes – in 5, 10, 15 years

Location + property + tenant selection

In addition to the choice of location and type of property, you, as the future landlord of a capital investment, also need to select tenants.

Let’s take a worst-case scenario as an example. Your tenant refuses to pay the rent, regardless of whether for personal reasons or financial reasons, and it takes 9 months to file an eviction suit. If the tenant himself is not sufficiently solvent, you will never see your money (costs of the eviction action) again.

Central, think about:

• Choice of location – structural vacancy? Less housing in the future
• Real estate type – How do you live? Micro apartment, instead of loft apartment
• Tenant selection – Who is a tenant? Creditworthiness (and trust)

The better you prepare for this when buying your first property, the better.

• Choice of location: A, B and C location
• Property type: Houses or apartments

Vacancy or not: loan installment must be paid

The vast majority of people finance their property. This means that you give about 15% equity and a bank gives you the rest (85%) as a loan. You repay the loan. The monthly installment of repayment and interest is called the loan installment. The bank doesn’t care if your tenant gets into trouble. You have to pay the monthly installment.

No matter what happens:

All costs continue to run!

Vacancies: influence on real estate yields

When buying real estate as a capital investment, the main focus is on returns. Simply put, the rental yield indicates how much rental income you achieve in relation to the investment (purchase price of the property, ancillary costs, maintenance). The result is a percentage. The higher, the better.

Example (simple):

• Investment in real estate: 100,000 euros
• Rental income / year: 3,000 euros
• Yield = 3%

3% would be relatively low, as you have to expect around 6% for interest/repayment and maintenance (currently). This means that your property must yield at least 6% to cover the costs.

As soon as you slip below ~ 6% yield, you pay more

Assuming you have calculated extremely tightly when buying real estate. So that you just achieve a 6% return, which covers the management / loan installment (interest and repayment). Now you have only 2 months of rent loss – the calculation is no longer correct and the yield drops to 5%. At 5%, the “missing” percent has to be paid out of your own pocket.

• Calculate real estate yield

Calculation: Return effect 2 months default

Let’s now calculate with the extremely tightly calculated 6% yield property. The big goal in all our guides:

Your tenant pays for your property = good return

Example 6% yield with full rental payment:

• Investment in real estate: 100,000 euros
• Rental income / month: 500 euros x 12
• Rental income / year: 6,000 euros
• Yield = 6%

Example effect of loss of rent (2 months):

• Investment in real estate: 100,000 euros
• Rental income / month: 500 euros x 10
• Rental income / year: 5,000 euros
• Yield = 5%

That means 1,000 euros out of your own pocket this year.

– 1,000 euros instead of “Tenant pays for your property”

Financial freedom? That’s why preparation is so important!

Tenants should therefore always be closely scrutinized. You should do a really thorough check.

• Self-disclosure
• Previous landlords speak
• Schufa information
• …

Rent arrears and reserves

It doesn’t always have to be a complete loss of rent. In practice, there are many reasons, for example, your tenant may not accept a rent adjustment following modernization measures. In other words, you modernize and adjust the rent and your tenant refuses to accept the rent increase.

Here, too, you are faced with the problem that you have made your investments and suddenly the tenant refuses. A dispute like this can go on for a long time and, in the worst case scenario, it can take 6 – 12 months before an eviction action is brought.

So that you can go into your first property without any worries, remember this:

Build up reserves!

What does that mean?

Building up reserves: security for the first property

Ideally, protect yourself financially against two possibilities:

1. Reserve for maintenance
2. Reserve for rent losses
3. Reserve for all eventualities

Reserves do not have to be set aside. However, they protect you from costs that you may not know how to cover spontaneously. Because, as you have learned, it doesn’t matter whether it’s rent arrears, loss of rent or vacancy:

All your costs continue to run

Reserve for maintenance

One cost factor that you will always have to bear is maintenance. More or less, of course, depending on the year of construction and condition of the property. In general, however, you already calculate 2% reserves for maintenance in the first yield calculation.

Part of the yield calculation, 2% maintenance reserve:

2% reserve for maintenance

Property for 100,000 euros (investment) = 2,000 euros reserve / year

Reserve for rent losses

In addition, a 6% rent reserve is recommended for possible rent losses:

+ 6% reserve for rent losses

Property for 100,000 euros = 6,000 euros reserve

6% would also correspond to a return of 6% = 1 annual rent.

Reserve: Extra, for all eventualities

Especially for the first property, without large assets of your own (as a rule), you should think about an additional reserve. Why? So that you never run out of money and miss a payment to the bank.

Ideally for the first property, not a must but security:

+ 10% extra reserve

Property for 100,000 euros = 10,000 euros reserve

Follow-up financing: risks and interest rate changes

Vacancies not only have a negative effect on yields. Most property loans have a fixed interest rate with a fixed term. At the end of the term, the conditions are renegotiated, known as follow-up financing.

This is where the 2 central aspects come into play again:

• Choice of location – structural vacancy? Less housing in the future
• Real estate type – How do you live? Micro apartment, instead of loft apartment

Lending: Factors

The bank also follows a clear path for follow-up financing. Let’s say you fixed the interest rate for 10 years for your first real estate financing. After 10 years, with 25 normal repayments, the remaining debt is around 76%. This must now be financed.

For follow-up financing, go back to your bank or to another one. If you are offered better conditions, it is worth obtaining alternative offers for the follow-up financing. Bank A, B, but also C will take another focused look at your property and you:

• Real estate
• Creditworthiness

Structural change: lower property valuation

Factor 1: Structural change – Because everyone is reassessed for the follow-up financing. Let’s say your fixed interest rate expires after 10 years and the bank says the property is now worth 20% less, for example because many people have moved out of the region in the last decade, property prices are falling and so on.

Banks want security, if the property is then worth less, the bank would have lost money in the worst-case scenario (loan installment defaults, forced sale/auction). So the interest rate rises.

Interest rate change: interest rate development in 10, 15, 20 years

Factor 2: Interest rate changes – Interest rates are currently lower than ever. It is impossible to make a serious forecast of what interest rates will be in 10, 15 or even 20 years’ time. However, a look back shows that interest rates in this country were still above 8% until 1990, 4-6% until 2000 and currently only 1-2% for real estate loans. If interest rates fall, it’s great for your follow-up financing. However, if interest rates rise, it’s bad, because then you pay more and the return calculation no longer works.

What to do? Tips for good returns

First of all: keep your eyes open when buying real estate!

Don’t buy yourself any problems!

Don’t buy yourself any problems, learn here with us step by step how to buy your first property, from the preparation, to the acquisition (finding profitable properties), to the purchase contract. By the time you’ve read our guide to buying your first property, you’ll know how important it is to find profitable properties in the real estate acquisition process.

Read here again:

• Choice of location: Buying an A, B or C location?
• Property type: Houses or apartments?

3 tips: Low interest rates

You now know that it is very unfavorable if the property suddenly costs money instead of bringing in money. What can you do? Here are 3 simple tips:

Tip 1: Buy cheaply – It sounds simple, but “the profit is in the purchase”. A piece of business wisdom that is also true when buying real estate. Buying cheaply means finding a property that is sold below market value, or that you, as the buyer, buy below market value. We have more on this topic here: Buying real estate.

Tip 2: Fixed interest rate – If you fix your interest rate for 10 years, you will have to take care of follow-up financing in 10 years. The longer the fixed interest rate, the longer you don’t have to worry about interest rate changes. To maintain the current low interest rates, you can agree a longer fixed interest rate, for example 15 years or 20 years. In case of doubt, until the end of the loan.

Tip 3: Higher repayments – If interest rates explode and ruin many yield calculations, higher repayment installments are an option to reduce interest rates. Interest is always calculated on the basis of the debt or, from the first payment, on the basis of the remaining debt. The lower the remaining debt, the lower the interest. With the current low interest rates, however, it is worthwhile financing real estate over a long period of time, as inflation ensures that your loan installment is always “smaller” in terms of purchasing power.

You can also start financing with more equity right at the beginning. This means that the loan amount is smaller and so is the repayment. This means that the loan is repaid more quickly and long-term interest rate changes no longer affect your financing.

Let’s summarize the 3 tips once again:

1. Purchase price – Buy cheaply (below market value)
2. Fixed interest rates – agree longer fixed interest rates (15 years, 20 years)
3. Repayment rate – Repay more or start with higher equity

Here are 2 practical tips for finding “problem-free” properties:

2 tips: Real estate viewing

Here are 2 practical tips for your real estate search.

Tip 1: Pay attention to the property management company – Is the property management company doing a good job from your perspective? In other words, do you have the feeling that the property management company knows what it is doing?

Tip 2: Owner-occupiers in the house – When you view properties, you also make sure that there are a few owner-occupiers living in the house. You tend to make sure that the property remains “well-maintained” in terms of its condition and the tenants.

In short, you pay attention to:

1. Property management and trust
2. Owner-occupier in the house

Why finance?

Acquiring a property is an important decision, whether as a capital investment, a home of one’s own or as a private provision. With the different types of financing it is possible for everyone to make his first home or his first capital investment possible. Before you enter into a financing you should deal with some points before. You should check your equity, consider the incidental acquisition costs, calculate interest and repayment, housing allowance and reserves, and calculate your monthly burden.

Own home or real estate as an investment

Buying your first own apartment or house is a purely emotional decision, whereas in the case of real estate as a capital investment, it is purely a matter of the economic aspect and therefore an emotionless decision must be made. In both cases, however, it is important to deal with a checklist and the ancillary purchase costs in order to avoid serious mistakes.

Buy first apartment

Buying your first own apartment is a great experience in life. To ensure that nothing goes wrong when buying your first apartment, it’s best to have a checklist at hand!

• Buy first apartment
• Buying an apartment: Checklist

Purchase price + ancillary purchase costs / credit rating (rule of thumb: how much is left over in the month?)

Buying an apartment or house always involves additional costs! To be able to cover these, you should think in advance about how high the maximum purchase price may be and how much money is available per month.

• Maximum purchase price
• Incidental purchase costs

Types of financing

If a property is purchased, the purchase price is usually paid off with the help of real estate financing. For this purpose, the buyer can choose from various types of real estate financing. From annuity loans, partition loans, full financing, construction financing to many other types of financing.

But what does financing actually mean? It is a measure for the procurement and repayment of capital. But some forms of financing require security in the event of default, which must then be recorded as a mortgage or land charge in the land register.

Annuity loan: Probably the best-known form of financing

An annuity loan is a typical form of real estate financing. The fixed installments must be paid regularly and consist of an interest and repayment portion. The special feature of the loan is that the amount of the installment remains the same throughout the entire term, but the ratio of interest and repayment changes nevertheless. With each payment, the loan debt decreases and the interest portion thus decreases, but the repayment portion increases.

Who is this type of financing suitable for? For security-conscious investors who want to count on fixed rates over the fixed interest period.

The most important in a nutshell:

• Fixed rates
• Composition of interest & repayment portion
• Steady rate
• Change of the interest & redemption ratio

Advantages and disadvantages of the annuity loan

Probably the greatest advantage of this typical form of financing is the constant installment, which allows a fixed monthly budget to be planned precisely. It is also often possible to make unscheduled repayments at certain times and thus repay the loan more quickly. One of the disadvantages, however, is a long fixed interest rate, which means that you are tied to monthly installments for a longer period of time. If your personal situation changes and you want to repay earlier, you will have to pay a high full repayment penalty for the early repayment. After expiration of the debit interest rate commitment, follow-up financing is usually required; the interest rates are based on the current market investment, which can be either positive or negative.

Advantages:

• High planning reliability
• Fast redemption
• Decreasing interest burden
• Accurate calculation of follow-up financing
• Residual debt fixed from the beginning

Disadvantages:

• No change of contract possible
• Agreement of unscheduled repayments for flexibility
• Credit institutions do not always accept unscheduled repayments
• Borrower must assume full repayment penalty

Reverse mortgage: mortgaging the owner-occupied home

There are different forms of financing to finance the dream of owning a house or apartment. The reverse mortgage is one type of many financing options. It is a loan that is paid out by an insurance company, bank or private individual. The basic idea behind it is that property owners borrow against their home and in return receive a loan with a fixed term from a bank, insurance company or private individual. The loan amount is then transferred as a monthly annuity or a one-off payment. A real win-win situation: owners can stay in their home and even supplement their pension at the same time.

Who is the reverse mortgage suitable for? This form of financing is particularly worthwhile for older people who are already retired and no longer want to leave their home, but still want to supplement their pension.

• Disbursement of a loan by insurance company, bank or private person
• Mortgaging of the home
• In return receipt of a loan with a fixed term
• Paid out as a monthly pension or a one-time payment

Advantages and disadvantages reverse mortgage

Do you have little or no equity capital available for buying a house? Then the reverse mortgage is exactly the right form of financing for you. It is especially suitable for retirees who have paid off their property with savings and income all their lives. A special advantage is that owners can live in the property until the end of their life and receive money for their property during that time. The pension can thus be supplemented. Thus a high planning security is created, since the height of the annuity, interest rate and running time are specified in advance. Clear disadvantages of this form of financing are fees and the interest rate of the loan. There may also be closing fees if the average age is exceeded and the inheritance is significantly reduced.

Advantages:

• Lifetime right of residence
• Pension is improved
• No interest or redemption payment
• Heirs can redeem real estate

Disadvantages:

• High fee costs
• Low payout amounts
• Elimination of inheritance
• Maintenance of the property

Here you will see the verification of the equity and monthly income, in order to then be able to set up a type of financing:

Repayment loan: Decreasing installment burden during the term

An amortizing loan is a particular form of financing characterized by a decreasing installment burden over the term of the loan. The interest portion decreases from installment to installment, so that it constantly decreases and becomes more and more similar to the repayment amount. Wondering if the amortizing loan is right for you?

If you want to pay off your loan quickly and efficiently, then this form of financing is suitable for you. However, you should have a regular and solid income so that the high installments can be paid at the beginning.

• Decreasing rate burden over the term
• Constant reduction
• Fast & efficient redemption
• Regular, solid income should be available

Advantages and disadvantages of the amortizing loan

The amortizing loan brings with it advantages and disadvantages that should definitely be weighed up against each other before concluding a financing deal. A significant advantage is that the borrower pays off a fixed amount per month, thus reducing the residual debt. However, the fact that the residual debt remains relatively high at the beginning and only decreases sharply at the end of the term is a clear disadvantage.

Advantages:

• Faster reduction of residual debt & interest amounts
• Free capital can be used
• Landlord may use proceeds from rent for increased repayment of principal
• Low total cost of credit

Disadvantage:

• Residual debt high at the beginning
• Additional costs for early reduction of residual debt
• Loan form rarely accessible to private individuals
• Longer term in most cases

Building savings contract: Combination of loan & savings

Very simple! This is a combination of real estate loan and usual savings. First, it is determined how much should be saved per month, which then results in the building savings amount. The contract is divided into several phases. In the first phase, the saver pays in a fixed amount each month. He then receives interest on this amount.

The second phase begins when a certain amount has been saved, for example 35 percent of the total amount. Then comes the allocation. You receive the right to a building loan at a lower interest rate for the remaining amount. The building savings contract is suitable for people who want to finance their dream of owning their own property as cheaply as possible. However, this financing option is not intended for short-term financing goals.

• Combi of loan and savings
• Different phases
• Monthly fixed amount with interest
• Allocation starts from a saved amount
• Right to soft loan
• Long term financing

Advantages and disadvantages of a building savings contract

A building savings contract has advantages and disadvantages. You can read more about this type of financing here.

Advantages:

• High security
• Capital guarantee
• Profit through government subsidies
• Intended use flexible

Disadvantages:

• Interest on credit balances lower in the initial phase
• High processing fees
• Monthly charge higher than other financing

Full financing: With little capital to own a home

There is little or no capital available for a real estate purchase? There is no opportunity to save money or you have just started to do so? This is exactly when full financing comes into play. The credit institution then takes over the missing equity capital and finances if necessary also the building additional costs. But then you have to keep in mind that the interest rates are higher.

• Little to no capital available
• Credit institution assumes equity
• Financing of ancillary construction costs
• High interest

Advantages and disadvantages of full financing

A property can be financed also quite simply without own capital funds, that can bring advantages, but also disadvantages with itself. First of all, short waiting periods are guaranteed, because you do not have to save until a certain point in time, the dream of owning your own home can be fulfilled directly. In addition, it is always good to finance as early as possible, so that one is free of costs before retirement age. Another advantage is that possible savings can be used for repairs or new furniture. But what are the disadvantages? There is a risk that the repayment can cause problems due to possible changes. This can be, for example, unforeseen unemployment or even incorrect calculation. Another point is high interest rates.

• No long waiting time
• Earlier repayment of the loan
• Equity subject to change

Disadvantages:

• Higher interest rates
• Longer redemption period
• Unforeseen life changes

A number of staff review the current market rate and adjust it to current loans:

Variable loans: Flexibility through variable interest rates

This is a type of financing that is particularly suitable for short-term real estate financing. The good thing about this form of financing is that you do not have to pay fixed debit interest, because the interest rate is always adjusted to the current market interest rates. The interest rates are always based on the Euribor money market rate. But what do you mean by Euribor interest rate? Very simple. It is a key interest rate of the European Central Bank. The interest rates are adjusted every three to six months to the interest rates of the variable loan.

But for whom is this form of financing actually suitable? Clearly for buyers with a willingness to take risks. Likewise for buyers and builders for whom financial security is guaranteed.

• Short-term real estate financing
• No fixed debit interest
• Adjustment to current market interest rate
• Interest is adjusted to the loan every 3 – 6 months

Advantages and disadvantages variable loan

Are you interested in a variable loan? Then you should definitely weigh up the pros and cons beforehand. It is clear that this is a high-risk loan. An unexpected rise in interest rates not only leads to higher costs, but also increases the loan rate. However, the loan also comes with its advantages. If the interest rate level remains the same over time or even decreases, then you save on the real estate loan. In addition, the loan can be terminated with a notice period of 3 months. Alternatively, borrowers also have a right to make unscheduled repayments of up to 100% at any interest rate adjustment.

Advantages:

• At Euribor waste useful, interest rates more favorable
• High security
• Cancelable at any time

Disadvantage:

• Development of interest rates uncertain
• Interest rate fluctuation makes monthly costs unpredictable

Construction financing with a life insurance

Normally, a construction loan is combined with a capital policy. This means that the buyer pays interest only at regular intervals. The repayment of the loan follows with the disbursement of the loan.

Advantages and disadvantages construction financing

As with any financing, there are advantages and disadvantages to financing construction with life insurance. One significant advantage is that a home savings contract with life insurance is more favorable than an annuity loan and the loan is also secured in the event of death. One disadvantage is that the return is very low.

Advantages:

• More favorable than a normal annuity loan
• Credit protection in the event of death

Disadvantages:

• Low return

Connection and interim financing

These types of financing are referred to as financing that is usually only invested for a short period of time. Here you can learn more about the respective interim financing:

Follow-up financing: renegotiation of the loan

This form of financing is a renegotiation of an existing loan. If the previous construction or real estate financing has expired after the fixed-interest period, one must deal with the follow-up financing from this point at the latest. Many buyers take out a loan to fulfill their dream of owning their own property. The fixed interest period for a house financing goes between five and fifteen years. A multiplicity of borrowers do not create it however in this time span the loan back to pay. This is precisely when borrowers can agree on a new arrangement for repaying the remaining debt.

Interim financing: bridging bottlenecks

Interim financing is financing that only runs for a short period of time. This form of financing can be used to bridge financial bottlenecks for a certain period of time. The owners of a property can provide immediate financial resources and then use them as equity.

Refinancing: restructuring of the loan

What is actually meant by refinancing? It means an adjustment or restructuring of a loan. Whether you have a personal or business loan, you should definitely have that loan reviewed every few years to make sure you have the most favorable loan. For example, you may have taken out many small loans that can be combined into one.