Profitability is one of the key topics of an investment project, and it is also one of the most debated. Highlighted with enticing figures by some sector players as a selling point, it is nonetheless delicate to grasp to avoid being misled. What are the elements that allow you to calculate it? Gross profitability, net profitability, what are we talking about? What can drag down your profitability? PATRIMOLINK offers some concepts to know to better understand profitability and give it its rightful place in your investment project.
The definition of profitability
In the case of real estate, it is the ratio between the total amount invested in a property and the benefits derived from it. It is primarily a performance criterion to evaluate the relevance of a purchase, based on objectives and available funds.
Profitability, a Central Element of Investment
Calculating it before starting is primarily about knowing where you are heading. This calculation will allow you to accurately estimate the required down payment and necessary cash flow to better plan for future investments.
If it is an important indicator for you, it is also for your bank. To study your loan offer, the bank will make its own calculations and draw its conclusions. Presenting a file with projections made by professionals (e.g., a rental value certificate from a real estate agent) will increase your chances of securing a loan with favorable conditions.
For more information on obtaining a loan as a non-resident, see our articles: “Non-resident Real Estate Investment: Everything You Need to Know to Get Financed” and “Rising Rates, Why It’s Still Worth Investing in Real Estate?”
Gross Profitability and Net Profitability
Gross profitability is calculated by dividing annual rents by the purchase price of the property and adding notary fees and furniture costs to the result. Gross profitability is mainly used to get a first idea about a property and/or to quickly compare it with others. Note: this calculation method varies depending on the actors. Some may tend to simplify the operation by only considering the acquisition cost of the property, excluding ancillary fees, to present higher figures.
Net profitability starts from this same calculation base but reduces the rents by operating expenses. It takes into account co-ownership charges, property taxes, and other fees (agency, insurance, etc.). Net profitability thus provides a more precise and serious estimate. It corresponds to a multifactor, detailed analysis that requires real groundwork.
Generally, at Patrimolink, we favor rather conservative estimates. We take into account operating expenses extensively, including management by a professional and tenant turnover, for example. We usually get net profitability figures that may seem lower than other actors but aim to be more realistic.
The important thing about profitability is not so much the final figure as its explanation. It is crucial to carefully analyze the calculation method used to compare what is comparable.
What Can Drag Down Profitability?
Several different factors can undermine your profitability. The first reason occurs from the acquisition, with too high fees. Obviously, we think of the purchase price, but it can also take the form of poorly anticipated ancillary costs: agency fees, notary fees, loan costs, renovation, or furnishing costs to make the property rentable.
Everything that affects rental income can then impoverish your gain. There is rental vacancy, but also everything related to a poor estimation of management costs: co-ownership expenses (major works), or refurbishment (water damage or other incidents), or maintenance.
There is also the issue of poorly evaluated rent: below market value, it does not yield enough; too high, the apartment does not find a tenant.
If some of these situations are unpredictable, nothing prevents you from anticipating them through pragmatic profitability projections.
What is Good Profitability?
Ultimately, what is good profitability? A quick search on a search engine shows it would be in double digits. Let’s be honest, this type of result is not common in the French real estate market. And often when achieved, it is synonymous with compromises in liquidity or location objectives.
In absolute terms, we could say there is no good or bad profitability. It will be appreciated based on your objectives and investment strategy. At a minimum, good profitability is one that allows you to cover most of your costs.
Is Profitability Really That Important?
Profitability is, after all, just a figure among all the others you will have to analyze during your investment. It is important, but it should not overshadow the others. Return on investment is a notion just as important, if not more, because it looks at the long term.
Profitability will depend on the property purchased and its location. To achieve high profitability, you often need to buy below market value and/or accept an increased risk factor. Buying at a low price is often synonymous with major works or a more remote location. A more distant property is more exposed to rental vacancy and less easy to resell (less liquid). Choosing a more central, more expensive property with lower profitability, conversely, ensures more certain long-term appreciation and more liquidity.
Return on investment also considers the financing mode of the property and includes the leverage effect allowed by the credit.
Therefore, focusing only on profitability is overlooking a significant part of your project’s projection and risking poor choices.
Profitability is a central element of your investment project, but it is not the only one. Understanding, anticipating, and evaluating it will be one of the key factors for the success of your wealth strategy. However, it should be balanced with other notions, such as return on investment.
Getting support is a good solution to avoid pitfalls and invest knowledgeably. Our network of partners and ourselves are at your disposal to realize your project.
This content is for informational purposes only and does not replace the regulations in force. Without consultation with our experts, PATRIMOLINK cannot be held responsible for any consequences resulting from the implementation of the advice and information provided in this article.
