Understanding yield and ROI (return on investment)

When investing in a buy-to-let property in Budapest, there are several factors to consider when calculating the yield and estimated return on investment over a period of time. The basis for calculation is understanding these factors:

Capital gain

This is the profit an investor makes when selling a property for a higher price than it was originally paid for. In Budapest, where the average yearly appreciation rate has been steadily measured at double digits in recent years, many investors opt to buy an investment property, rent it out and then sell it after after 5 years in order to benefit from both tax benefits and a substantial long-term profit, as prices rise over time.

Rental yield

In investment properties, yield is expressed as a percentage, and it is calculated from the rental money generated by renting out the flat to tenants.

Gross yield 

This relates to the total sum of the income return created from the property investment, before deducting any related expenses, vacancies, or mortgage interest rates.

Net yield

This relates to the total sum of income generated from the property after its rented, after any expenses are deducted from it. The net yield is often referred to also as “rate of return”.

Tip – is it correct that it’s possible to gain higher yield in cheaper area?

When it comes to Budapest, there are typically two main profiles of investors looking into buying properties in the city.

1. Since Budapest is a global higher-education centre, with dozens of universities, there at close to 30.000 international students in the city starting their semester annually. Many of these young students buy a flat in the city center for the duration of their studies, as that way to can either enjoy from passive income once finishing their studies and going back to their country of origin, or sell the property when finishing their studies to benefit from the capital gain, which ofter is used to cover the cost of their past years tuition.
2. Since Budapest is not only a major “university city”, but also a strategic business hub due to its prominent location in the central of Europe, there are, on top of the thousands of international students, also thousands of international corporate employees, young families and professionals, looking for accommodation in the more centre and accessible parts of the city. Investments in properties that are then rented to these two large niches of foreign students and expats are often the target of professional investors, as they know that the can generate higher yields from rent.

So, while in concept or as a rule of thumb, investors can get higher yields in cheaper areas, specifically in the case of Budapest, it is also important to consider the gator of the tenants, which since they are mostly foreigner living, working and studying in Budapest, they tend to concentrate on the more central parts of the city, such as the inner parts of districts 5,6,7,8,9,13 in Pest, or districts 1,2,3 in Buda, which are more popular with diplomats and younger couples. More about the different districts in Budapest can be found in this useful districts guide.

Expected expenses when buying a property in Budapest

When calculating the ROI of an investment property, it is required to factor also the expected expenses, which mainly include:

• Mortgage repayment and interest
• Insurance
• Purchase and transaction costs
• Vacancy costs
• Property management fees
• Maintenance and repairs

Formula for calculating the yield

There are different ways to calculate the yield from investing in property, however since Budapest is a preferred destination for mid-term property investors, meaning – completing buying and selling a property after 5 years or so, the basis of calculation should reflect the capital gain on the property and the net yield from rent during this period.

Example:

You purchase a property for 150,000 euro

The purchase transaction costs (tax, legal, commission, other) are around 10% or 15,000 euro

Your total investment = 165,000 euro

Now you need to calculate the income

➤ Income from rent over the period

Monthly rent 650 euro, so the total annual income from rent is 7,800 euro (650 euro x 12 months)

As for annual expenses (property management if needed, maintenance, fixes, etc.) we will use a very careful assessment and calculate it as ~20% of the total rent, or 1,560 euro annually

From these two numbers, we can calculate the net annual income, which is 6,240 euro. So over a period of 5 years in which the property is rented, the total net yield from rent is 31,200 euro (6,240  x 5)

➤ Income from capital gain as result of appreciation in the value of the property

After a period of 5 years, you sell the property for 200,000 euro (which based on previous years average annual appreciation value, is a very cautious estimation). The capital gain from the sale after 5 years is 35,000 euro (the difference between the selling price and the total purchase price)

Now you need to combine the income from rent and the income from capital gain over this period of 5 years, which comes to a total of 66,200 euro (31,200 + 35,000).

Divide the total amount from income over 5 years to get the annual income, which is 66,200/5 = 13,240 euro.  

Now you can calculate the expected net yield on your property investment, which is the net annual amount generated from income (13,240) divided to the total purchase price (165,000), or:

13,240 / 165,000 = 8% annual net yield.