Property Profitability (Cap Rate): How to Know If Renting Is Worth It
Brazilians have a historical passion for investing in "bricks". Physical property has always been seen as synonymous with security, solid assets and a guaranteed source of passive income in retirement through rentals.
However, in the modern financial market, where Fixed Income usually pays high interest rates without any headaches, is buying an apartment to rent still the best deal?
The only way to answer this without emotional bias is to calculate the Cap Rate of your property. In this guide, we will teach you the mathematics behind real estate funds applied to your apartment.
What is Cap Rate?
Cap Rate (Capitalization Rate) is the most important metric in the real estate market. It represents the annual rate of return that an investment property generates in relation to its market value, considering that it was purchased in cash.
The Cap Rate tells you, in percentage, how much money your property returns to your pocket per year.
The Gross Cap Rate Formula
The most basic mathematical formula is:
Cap Rate = (Annual Rental Income / Property Market Value) * 100
Practical Example: You bought an apartment for $ 500.000,00. Você consegue alugá-lo por $ 2,500.00 per month. The gross annual income will be $30,000.00 (2,500 x 12). Cap Rate = (30,000 / 500,000) * 100 = 6% per year.
In a simplistic scenario, this property yields 6% gross per year. But real life is not simplistic.
The Reality Shock: Net Cap Rate (NOI)
The rough calculation misleads many investors, because ignoring the operating costs of a property is a fatal mistake. To obtain real profitability, we need to use the concept of NOI (Net Operating Income or Net Operating Revenue).
From the gross annual rental income, you must subtract:
- Vacancy Rate: The property is not rented 100% of the time. It is estimated at least 1 month of vacancy per year (or 8.33%).
- Income Tax (IRPF): Rent received from individuals is taxed on the Carnê Leão tax, which can reach 27.5%.
- Administration Fees: If the property is owned by a real estate agency, it charges 8% to 10% of the monthly rent.
- Maintenance and IPTU during vacancy: Infiltration, painting and IPTU that you pay while the property is empty.
If we apply these discounts in the previous example, the annual net rent that falls into your pocket probably drops to around $18,000.00. Your real Cap Rate plummets to: (18,000 / 500,000) * 100 = 3.6% per year.
Rent vs. Fixed Income (CDI / Treasury Selic)
When you discover that your property yields 3.6% net per year, you should compare it with the market's "Risk Free Rate": Fixed Income.
If the basic interest rate (Selic) is 10% per year, a CDB or Treasury Selic would yield approximately 8.5% per year net (already deducting income tax from the financial investment).
In this mathematical scenario, your $ 500.000,00 investidos no banco renderiam $ 42,500.00 for the year, with no risk of the tenant not paying, no infiltration to fix and with daily liquidity (you can redeem the money immediately). The property is yielding just $18,000.00.
Does Property Appreciation Save the Account?
The main argument of real estate investors is that, in addition to rent, the property appreciates over time. This is true in the long run. However, for real estate investment to beat Fixed Income in high interest rates, the annual appreciation of the property has to be absurdly higher than inflation. In bad economic cycles, property prices can even fall in real terms.
How to Simulate the Return on Your Property?
Don't try to calculate all these deductions, vacancies and compound interest in a disorganized spreadsheet.
To help property owners and investors make purely logical decisions, we created the Property Yield Calculator.
You enter the value of the property, the desired rent, the cost of the condominium/IPTU and the interest on the current Fixed Income. The tool calculates your Net Cap Rate and tells you, in reais, whether it is better to rent the property or sell it to put the money in the bank. Access for free and take the test!