Investing in real estate: how to make money on a mortgage

In 2023, the real estate rental market for an investor may become more attractive as mortgage lending conditions worsen, sure Cyan.Analytics experts. Mortgage market rates are already rising and may rise even more if the Bank of Russia raises the key rate. He gave a signal to that at the last meeting of the Board of Directors and analysts give the same forecast. The number of those willing to take on debt obligations may decrease relative to the number of tenants. The rebalancing of supply and demand for rental apartments will open up good opportunities for real estate investors, especially those who have the opportunity to take out mortgages at a reduced rate.

How to become a rentier and how much you can earn on real estate taken on a mortgage, Valery Yemelyanov, an expert on the stock market at BCS World of Investments, told RBC Investments. In addition, the expert calculated what the down payment and mortgage rate should be, the rental rate that would bring income, and the cost of equipping the apartment, and also compiled a table for independent calculations of investors.

The calculation of a profitable down payment on a mortgage for an investment apartment depends on the ratio of rental rates, the mortgage rate and the growth rate of the price of the apartment. In the current market, with a non-exempt mortgage rate of 9% for second homes and a rental rate of around 4%, it is clear that the cost will be higher than the return on any installment. If you add to the equation a long-term increase in the price of an apartment, which has been 4-5% per year for the last 10 years, then in total you will still get a plus with such an investment. And the yield will be at the level of a bank deposit – about 8% per annum for 20 years (the average mortgage term).

In general, you should consider this: if the rental income (annual payments divided by the cost of the apartment) plus the average increase in its value turns out to be higher than the mortgage rate, then it is more profitable for you to take the maximum possible loan, that is, to make the minimum down payment. So you get a head start in time and more rubles for each ruble you personally invested.

For example, if you took a mortgage at 7% (there are even lower rates in the primary market), rented it out at 4% per annum (the usual rate for Moscow), and your apartment at the same time rises in price at least at an average market rate of 4.5% per year, then with a minimum contribution of 10% over 20 years you will receive an average of 9.9% per annum. If the contribution rises to 20%, then your yield will drop to 9.6%, if you invest 50%, you will receive 8.9% per annum, all other things being equal.

With a rate of 9%, which is higher than the sum of the average increase in the cost of housing plus rental income (4% + 4.5% = 8.5%), the opposite is true, although the difference is also not critical. With a minimum contribution of 10%, you will earn 7.9% per annum, with a 20% contribution – 8% per annum, with 50% – 8.2%. That is, it turns out that it is a little more profitable to pay off the mortgage as quickly as possible or to initially take it with a smaller loan relative to the cost of the apartment.

The key point and the most volatile in these calculations is the rise in housing prices. It is unpredictable, but for the last 10 years it has averaged 4.5% per year in Moscow, taking into account good and bad years. It is not significant to analyze the previous 20 years, since they include the oil boom, and the model turns out to be too optimistic for the investor. If there is no increase in the price of an apartment for all 20 years, then the apartment will bring losses. If the growth is, but weak, then the yield will be lower than on current deposits. For example, with the same standard parameters and rates as now, for Moscow, with an increase in housing prices by 1% per year, the profitability for all 20 years will be almost zero – how much you invested, so much returned, taking into account rent and growth, if 2%, then the yield is about 3% per annum, if 3%, then almost 5% – the dependence is not linear.

The loan rate should preferably be lower than the rental rate. There are cities, and even large ones like Chelyabinsk, where this phenomenon is observed. You can buy an apartment in a mortgage at 6% and rent it out at 7% per annum. But this is an exception to the rule. Rather, this is the rule for problematic cities, where there is low demand and a high outflow of the population. Typically, rent brings about 6% at best, and mortgages are given at 8% or more.

It is optimal if you find an object that is objectively in a good location and relatively inexpensive, that is, you understand that it can grow in price no worse than the market in your city as a whole. If this growth is in the range of at least 2-5% per year and you receive at least 5% from rent, then you already have a reserve of 7-10%. The mortgage rate should not be higher, then the investment will definitely pay off.

By itself, the price of renting a property does not matter. It is important how much you can rent for relative to the price of the apartment. Moscow 4% and even lower is the worst option, and Chelyabinsk almost 7% is a very interesting option. Although in the first case you will pass quickly, in the second it will be more difficult and longer.

You are unlikely to be able to pay off your mortgage with rent payments. Don’t expect tenants to pay off your mortgage. Due to the peculiarities of the annuity, your payment per year is always higher than the rate at which you took out a loan, since interest and the body of the loan “sit” in the mortgage payment. But time will work for you. And, if the rates are successfully correlated, then with a rent at 5%, a mortgage of 9% and an increase in the price of an apartment by the same usual 4.5%, your rent will become more mortgage payments in the 15th year of the loan.

Rentier also benefits from inflation – rising house prices are precisely because of it. If inflation accelerates to, say, 10%, then you will cover your mortgage payments with rental income in 10 years, despite the “draconian” loan rate.

The payback period must be calculated for different periods of the mortgage, that is, build a model with early repayment, as if you were selling an apartment in 3-5 years and then bringing the cash flows together. In general: in a stable market, when real estate is growing smoothly, and your rates are in your favor, that is, mortgages are cheap and rent is expensive, you will be in the black from the first day of purchase.

On average around the world, a normal fork for rental costs is 1-3% of the cost of housing per year. If this is translated into money, it becomes clear that in Russia the numbers are about the same. For example, for an apartment worth ₽10 million, an expense of 2% is ₽200 thousand per year, which just corresponds to repairs every five years by about ₽700 thousand (about ₽20 thousand per meter) and ₽300 thousand for utilities and taxes (₽5 thousand per month, or ₽60 thousand per year). This 2% should be subtracted from the calculated return given above. That is, if the estimated yield is 7.9%, then minus the cost of equipping and maintaining the apartment, the yield will be 5.9% per annum.

• Rental rate (annual) – 4%;
• Real estate price growth, average per year – 4.5%;
• Mortgage rate — 9%;
• Initial payment – 10%;
• Loan term – 20 years;
• The cost of the apartment is ₽10 million.

With such initial data, the price of an apartment over 20 years will increase from ₽10 million to ₽23.079 million, annual rental payments for the same period will increase from ₽400 thousand to ₽923 thousand, the mortgage payment will remain unchanged at ₽972 thousand in year. The internal profitability of the apartment, excluding the cost of repairs and equipment, will be 7.9% per annum. If regular expenses for apartment maintenance amount to about 2% of the cost of housing per year, then the yield will be 5.9% per annum.

The yield from long-term rental of apartments from January to December 2022 decreased from 5.4% to 5% per annum in the primary market and remained at the level of 5.9% over the same period in the secondary market, according to data “Cyan.Analytics”.

The maximum return on investment in real estate among million-plus cities (data from Cyan.Analytics as of December 2022):

• Chelyabinsk – profitability of primary housing – 6.6%, secondary housing – 7.5%;
• Rostov-on-Don – profitability of primary housing – 5.9%, secondary housing – 6.6%;
• Yekaterinburg – profitability of primary housing – 5.6%, secondary housing – 6.6%;
• Voronezh – profitability of primary housing – 6%, secondary housing – 6.4%;
• Novosibirsk – the yield of primary housing – 5.3%, secondary housing – 6.3%.

The minimum return on investment in real estate among million-plus cities (data from Cyan.Analytics as of December 2022):

• St. Petersburg – the yield of primary housing – 4.1%, secondary housing – 4.6%;
• Kazan – profitability of primary housing – 3.8%, secondary housing – 4.7%;
• Moscow – profitability of primary housing – 4.5%, secondary housing – 4.8%;
• Ufa – profitability of primary housing – 4.4%, secondary housing – 5%;
• Nizhny Novgorod – the yield of primary housing – 3.9%, secondary housing – 5.6%.

The maximum profitability when renting housing for rent among the locations with the largest number of bookings can be obtained in sightseeing cities. By Cyan.Analytics datathe maximum average daily rental rate with a occupancy of 50%, that is, two weeks from the entire month, in December 2022 was in the following cities of Russia:

• Nizhny Novgorod – 11% per annum;
• Yekaterinburg – 11%;
• Novosibirsk – 10%.

In 2022, due to air traffic restrictions in the south of Russia, there was an atypically high demand for million-plus cities. In Sochi and Gelendzhik, due to expensive real estate, the yield is 6-7%, the experts of Cyan.Analytics calculated.