Investing in a Spanish rental property can provide you with not only a second home in the sun but also steady rental income or capital appreciation when the property is sold for a profit. However, if your Spanish property purchase is primarily an investment, it is important to measure the return on investment (ROI) of the property to determine the level of profitability.
When deciding where to invest in your Spanish property, be careful, ROI calculations can be easily manipulated – and certain variables can be either included or excluded when making the calculation.
In this article, we’ll review two examples for calculating ROI on Spanish rental property. We will look at purchasing with cash and also with a mortgage. We will also highlight additional costs that sellers agents may not always remember to warn you about when making your calculations. We include a link to our Buyer’s Agent Spain online tool to calculate the ROI on Spanish rental property, for your own use,
What Is Return On Investment (ROI)?
Return on investment (ROI) measures how much money or profit is made on an investment. It is calculated as a percentage of the cost of the investment. Investors use ROI to determine how an investment is performing. It is also used to compare with the performance of other investments.
In simple terms, to calculate the profit on any investment, you take the total return on the investment and subtract the original cost of the investment.
ROI is a profitability ratio meaning it gives us the profit on an investment represented in percentage terms. To calculate the percentage gain on an investment, we take the net profit or net gain on the investment and divide it by the original cost as shown in the formula below:
Calculating the ROI on Rental Properties
While the above equation seems easy enough to calculate, with property investment, a number of variables, including repair/maintenance expenses, mortgage payments, the amount of money borrowed (with interest) to make the initial investment, come into play, which can affect ROI numbers.
When purchasing property, mortgage terms can greatly impact the price of the investment. Using a mortgage broker can help you save money by helping you find favourable interest rates and conditions. (Contact us for our recommended partners)
In Spain, you need to add on taxes such as IBI, Basura, non-resident income tax, irpf (as mentioned in a previous article). We strongly recommend you consult with a reliable accountant/gestor before calculating your own ROI on Spanish rental property. (NOTE: Our bespoke property finder service includes this consultation as part of the initial research process).
Calculating the ROI on Spanish Rental Property: Cash Purchase
If you buy a property outright, calculating its ROI is fairly straightforward.
Here is an example of a rental property purchased with cash:
- You pay €100,000 in cash for the buy to let property.
- The purchase costs are €12,000 bringing your total investment to €112,000 for the property.
- You collect €500 in rent every month.
12 months later:
- You earned €6,000 in rental income for that year.
- However, there were expenses including the non resident tax, property taxes, and insurances totaling €600 for the year or €50 per month. *(NOTE: there are many expenses that can be deducted to improve your annual rental income figure, check this with your gestor/accountant)
- Your annual return is €5,400 for the year (€6,000 – €600).
To calculate the property’s ROI:
- Divide the annual return (€5,400) by the amount of the total investment or €112,000.
- ROI = €5,400 ÷ €112,000 = 0.048 or 4.8%.
- Your ROI is 4.8%.
Calculating the ROI on Spanish Rental Property: Purchase with Mortgage
Calculating the ROI on financed transactions is a little more complicated.
For example, you purchased the same €100,000 rental property as above, but instead of paying cash, you took out a mortgage.
- The down payment needed for the mortgage was 40% of the purchase price or €40,000 (€100,000 sales price x 40%).
- Total purchase costs are higher (14%) due to the mortgage, totalling €14,000.
- Your total purchase costs are €54,000 (€40,000 + €14,000).
Plus, there are ongoing costs associated with the mortgage.
- Let’s assume you took out a 25-year loan with a fixed 2.5% interest rate. On the borrowed €60,000 (€100,000 sales price minus the €40,000 down payment), the monthly principal and interest payment would be €269.17.
- Rental income of €500 per month for a total of €6,000 for the year.
- Your monthly cash flow was of €230.83 monthly (€500 rent – €269.17 mortgage payment).
Over 12 months:
- You earn €6,000 in rental income for the year, at €500 per month.
- Annual adhoc costs of €600 based at €50 per month
- Your annual return is €2169.96 (€230.83 x 12 months).
To calculate the property’s ROI:
- Divide the annual return by your original purchase expenses (the deposit payment of €40,000, plus purchasing costs of €14,000) to determine the ROI.
- ROI: €2169.96 ÷ €54,000 = 0.0502.
- Your ROI is 5.02%.
So there you have our introduction to how to calculate ROI on Spanish rental property. In our introductory examples, for ease of comprehension, we focused solely on long term rentals. There are many more methods and calculations should you wish to delve deeper. This article may be of interest: “How to Value a Real Estate Investment Property.”
From these simple calculations, you can see that ROI differs depending on whether the property is financed via a mortgage or paid for in cash. In general, the less cash paid upfront as a down payment on the property, the larger the mortgage loan balance, the greater your ROI. Conversely, the more cash paid upfront and the less you borrow, the lower your ROI, since your initial cost would be higher. In other words, taking out a mortgage allows you to boost your ROI in the short-term since your initial costs are lower.