Back in 2016, I made my first big investment: I bought an apartment.
I had a few reasons why I wanted to get into real estate:
- The market in my city had been growing significantly over the last years
- I had a decent amount of cash that I wanted to do something productive with
- I liked that I could build capital instead of “wasting money” on rent
- I liked that if I didn’t live there, I could rent it out for a passive income
- Some personal finance bloggers were positive about real estate as an investment
- The stock market somehow seemed “risky” (I guess index funds were new to me)
While these reasons all sounded good to me at the time, I have to be honest: I didn’t fully do the math on this investment, and I didn’t really know what I was getting into. In fact, I never even saw the property in person before buying it, as I was living abroad at the time.
So, five years on, let’s review this investment with a slightly more money savvy lens. Was this a good investment? To understand that, I’ll break down each part of the deal.
Purchase price & mortgage
The purchase price was 217,500. I made a down payment of 67,500 (31%) and took out a mortgage for the remaining 150K at an interest rate of 1.93% fixed for 15 years.
I was not sure how long I would be living in the place, as I was just returning from abroad and did not know if I wanted to settle in the city long-term. Therefore, I needed a mortgage structure that could be covered easily with rent, which led me to chose a low monthly mortgage payment of just 500 EUR.
Based on that alone, it would take me a very long time to pay off the mortgage. After the 15 year fixed term, I would still owe nearly 100K. Assuming that I would be able to extend the mortgage at the same interest rate beyond 15 years (unlikely), it would take me until 2050 to pay off the mortgage. Yikes.
Luckily, I did enough math at the time to negotiate an option to make a special principal repayment of up to 7,500 EUR per year. This was important to me, because it gave me flexibility to pay back more if I was able to do so, but I was not locked in to paying a large amount each month. If I was able to make the full additional payment of 7,500 each year, I could finish as early as 2029. In order to pay off the mortgage by its end date, I would need to pay off 6,000 extra each year.
That sounded reasonable to me at the time, and still does. So far, I’m nearly on track with that plan.
Looking back, that was quite a large down payment. I probably should have put less money down. With such a low interest rate, it likely would have been better to take on a higher mortgage and rather invest some of the extra money in index funds. Of course that’s easy to say now, looking back on one of the strongest bull markets ever.
With the benefit of hindsight, I also think that the monthly repayment is too low. Now that the apartment is rented out, I wish that I had a higher monthly repayment, purely for tax reasons. I can offset the interest costs against the rental income. Thus, a higher repayment would actually save me money on taxes and the mortgage would automatically get paid off faster.
Mortgage structure matters. Make sure that you fully understand the pros and cons of a larger vs. a smaller down payment. Also, choose your monthly payments carefully and decide how important flexibility is to you. These decisions will affect you for years to come, positively or negatively.
Where I live, closing costs are quite a whopper. To the best of my records I paid roughly 2K to the realtor (this is comparatively low as the seller paid the majority of the realtor’s fee), 3K to the notary, 0.7K in legal fees and a whopping 13K in taxes.
In total, the fees came to roughly 19K, meaning, I basically started my real estate journey “down” 19K already at the moment of purchase. That’s 9% on top of the purchase price just in fees.
On first glance, it looks like a lot. However, I actually got lucky here because the seller paid a large portion of the realtor fees. On other properties, I’ve had fees up to 15% of purchase price.
This is something to keep in mind when considering real estate as an investment. Before you can make a return, you first need to earn back the closing costs.
Fees are a part of life. In this case, I couldn’t really do anything to reduce the fees, and in comparison to other properties I saved money as the seller covered most of the realtor costs. However, of course fees are something to be aware of and they harm the potential return.
Remodelling & modernization
The apartment I bought has two bedrooms across two storeys that are connected with an internal staircase. I saw a lot of potential in the place, but I also knew that I would need to invest some extra cash to realize that potential. The bathroom definitely needed re-doing. I also wanted to have the option to rent out the downstairs part on Airbnb, so I needed to add some walls to separate upstairs and downstairs, and install a downstairs shower.
I can’t track it exactly anymore, but I would estimate those costs were around 34K in total. That is very substantial, as 15% of purchase price. Could I have sold the apartment for 251.5K directly after the renovations? I am not convinced.
It also ended up costing more than I budgeted for initially. The quote I got at the start of the construction work was lower, but as it’s a relatively old house, the contractors found some unexpected surprises as they went along with the works. That ended up making it more expensive than I thought.
I think this outcome was caused by wanting too much. This was my first property and I had grand plans. But grand plans cost money, and I never did the math on how long it would take me to recover the investment or think about these costs as a percentage of purchase price. I should have!
Given that I only house-hacked for a short time before buying another apartment and moving out, I probably should have kept remodelling expenses to a minimum. Some changes like the bathroom upgrade, were most likely a good investment long-term, but I probably shouldn’t have bothered to make the place Airbnb-ready. I reckon I paid at least 15K too much here. Ouch.
Before investing in remodelling, do the math. How much extra income can you make based on these changes? How long will it take you to recover the costs? Is it worth it? Can you spend less and get nearly the same benefit? Make sure that you know what you are getting yourself into, and always leave some space in your budget in case that the final cost turns out higher than you thought.
This is where my bad record keeping is coming back to bite me. Similar to the modernization, I cannot say anymore exactly how much the furniture set me back. I know that the kitchen cost me around 6K, and I would estimate that all the furniture in total probably came to around 10K.
Of course, I can charge slightly more in rent because the place is fully furnished, but again, it’s a cost that I need to earn back, before I can enter profit territory. Also, renting furnished means that I am liable to replace any furniture that breaks down, which can potentially harm returns even more.
At the time, I needed furniture because I was living there myself, and, coming from abroad, I didn’t have any. So this is not really a cost I could have avoided at that point in time. However, if I was purely looking at the apartment as an investment, I would not bother furnishing it and instead let tenants make their own choice. Providing a kitchen might be a plus to attract tenants, but my gut feeling also says that tenants will be more likely to stay longer if they’ve furnished the place themselves.
Total Cost – “All in”
After accounting for the purchase price, closing costs, remodelling and furnishing the apartment, I actually ended up spending 280K.
Of course, “only” 130K came from my pocket, thanks to the 150K mortgage. Still, that’s a very substantial amount for a first investment. Looking at it that way, it also means that I technically paid even more money as a down payment, nearly half of the total cost.
Looking back at this, I really spent far too much money on top of the purchase cost, setting myself up with a mountain of cost to recover before being able to make a profit. I also paid far too much out of pocket and would certainly look to reduce that share in the future.
Initially, my plan was to rent out the downstairs part of the apartment as a self-contained flat on Airbnb, while I would live exclusively upstairs. As I didn’t cook much at the time, I thought I wouldn’t mind not having kitchen access, and being an Airbnb landlord would make for an interesting experience. Plus I could make more rental income that way as compared to subletting a room permanently.
It didn’t quite work out that way. When all the remodelling was done, one of my friends needed a place to stay on short notice, so I rented the downstairs part to him instead as a flatshare arrangement. Less risk for me plus kitchen access and a nice housemate, but obviously lower returns. Overall it was a good experience, as my tenant subsidized my mortgage. I would definitely recommend house-hacking if your setup allows for it.
After about a year and a half however, I ended up buying another apartment and moving out. My tenant took over the whole apartment and has been living there ever since. I have to admit that I probably left money on the table in terms of rental income. As mentioned, the tenant is a long-term friend of mine, so he got a “mates rates” deal. For me, the peace of mind of having a reliable tenant who will treat my place well is something that I value, so I was and still am happy with that arrangement.
I may not be fully maximizing rental returns, but the rental arrangement has been very low maintenance, my friend has a nice place to stay and my mortgage gets slowly paid off. I’ve had zero vacancy and zero problems so far. That’s a good outcome in my book.
What about the return?
I’m not sure if I’ve found the perfect formula to measure return from rental properties yet, so if you have a great way to measure it, be sure to leave me a comment!
For now, I’m following the approach laid out by Joel in this article. I’m measuring both the return on equity in the home (calculated by purchase price less remaining mortgage balance), as well as the return on total investment (equity in home + closing costs + remodelling + furnishing expenses).
To compute the profit on the property, I’m taking the rental income and deducting my costs, which are mostly made up of some property management costs, the interest payment on my mortgage and an estimation of tax liability.
As you can see, the total return on equity comes in at 4.1%, while the return on total investment is lower, just 2.5%. The biggest driver of the difference between the two are the remodelling costs. Neither of these numbers are great though. That’s a pretty low return for such a large investment.
Even though I may not be fully maximizing rental income, the biggest driver of these low numbers are certainly the suboptimal decisions I made relating to down payment, remodelling and furnishing.
Let’s look at a hypothetical scenario of how I would optimize this investment based on the benefit of hindsight. For this scenario, we will assume:
- Only 10% down payment (21,750)
(therefore ~46K equity less in the home)
- Only 20K remodeling cost
(guesstimate to only do beneficial work)
- Only 6K furnishing cost
(kitchen yes, but no other furniture)
Well those numbers certainly look very different!
If I had done it this way, I would classify that as a decent return. And still more would be possible. I could probably have asked for similar rent without any remodelling at all. Hindsight is beautiful, but hopefully, these lessons will help me avoid similar mistakes in future properties.
I’m not losing money, but the return is definitely sub-par, driven by bad decisions right at the start.
The lower your cash outlay at the beginning, the higher your return on equity and total investment will be, given the same rental income! Rental income can grow up to a certain point. But everything you spend at the beginning will continue hurting your numbers for years to come.
In fact, ROE and ROI will likely drop over the lifetime of the investment, as equity in the property grows. So if these metrics are important to you, try to keep your equity and other costs as low as reasonably possible.
So was this investment a bad decision overall? Well, we have yet to account for one final factor that may turn this into a winner yet. That factor is price appreciation.
The Bonus: Price appreciation
I’m certainly not an expert at valuing properties, but I have seen very similar apartments in the same neighborhood being offered around 295K recently. Just in case, let’s discount that a little, and assume that my property would currently be worth 285K.
That would mean an appreciation of 67.5K or 31% over 5 years. If that’s true, that’s not too shabby! Coincidentally, that would earn me my entire down payment back. It would also exceed my total costs ever so slightly, potentially yielding me a 4K profit on sale. Not much, but better than being “under water”.
If I was to sell the apartment at that price today, I would be exposed to capital gains tax though. As I am not living in the property myself, I need to hold it for at least 10 years before being able to sell without capital gains tax liability. But that’s not really a problem for me. As with all my real estate investments, I plan on holding this property for a long time.
The Bottom Line
I definitely made some mistakes with this investment right from the start, but thanks to capital appreciation, I could already be near positive territory. I’m also making a small return on investment each year. It’s not terrible, but it’s not a clear winner either.
Perhaps most importantly, I have learned some important lessons. These lessons will surely benefit me for future real estate purchases, so I’m very glad that I learned them early.
Since I don’t plan on selling any time soon, the apartment will hopefully continue to great capital appreciation. Eventually that will likely more than make up for my mistakes at the beginning. Fingers crossed, and on to the next one!
Do you have any experience with real estate? How do you measure your returns? Do you have experiences with renting furnished compared to unfurnished? Have you learned important lessons that you want to share? Let me know!