How to Determine if a Property is a Good Investment

When considering whether a property is a good investment, calculating its value relative to its rental income can help you make an informed decision. According to Bankinter, you can approximate the fair price of a property using specific metrics such as Gross Rental Yield and Price-to-Earnings Ratio (PER). Here’s how they work:

1. Gross Rental Yield

This metric shows the annual return on a property as a percentage of its purchase price.

Formula:

Gross Rental Yield (%) = (Annual Rental Income / Sale Price) × 100

Example Calculation:

  • Annual Rental Income = €12,000
  • Sale Price = €240,000
Gross Yield = (12,000 / 240,000) × 100 = 5%

2. Price-to-Earnings Ratio (PER)

The PER measures how many years it would take for the rental income to equal the purchase price of the property.

Formula:

PER = Sale Price / Annual Rental Income

Example Calculation:

  • Sale Price = €240,000
  • Annual Rental Income = €12,000
PER = 240,000 / 12,000 = 20 years

Using PER to Analyze Investments

A low PER (below 25, according to the Spanish average) often indicates a better investment for buyers, while a high PER suggests renting may be more advantageous.

Quick Reference:

  • Sale Price ≈ PER × Annual Rental Income
  • Rental Income ≈ Sale Price ÷ PER

Real-World Application: Spain’s Property Market

The Bank of Spain reports the average gross rental yield is 4-5%, corresponding to a PER of around 27 years. This data can be used to estimate approximate sale or rental prices.

Example 1: Estimating Sale Price

If a property rents for €1,500/month:
Annual Rental Income = 1,500 × 12 = 18,000 euros
Sale Price = 18,000 × 27 = 486,000 euros

Example 2: Estimating Rental Income

If a property is sold for €270,000:
Monthly Rental Income = 270,000 ÷ 325 ≈ 830 euros

Adjustments Based on Location and Property Condition

1. Location Matters

Cities with high demand, such as Madrid or San Sebastián, often have higher PERs. For instance:

  • San Sebastián’s PER = 24 years
  • Santa Cruz de Tenerife’s PER = 13 years

Even within a city, PER varies by district. For example:

  • Madrid’s Chamberí District: PER = 24
  • Madrid’s Villa de Vallecas: PER = 18

2. Property Condition

Better-maintained or luxury homes often have higher PERs, reflecting their increased desirability.

Conclusion

Using formulas like Gross Rental Yield and PER helps you evaluate the potential of a property as an investment. However, remember to adjust for factors like location, demand, and property condition to ensure accuracy.

When in doubt, consult local market data or professional advice to validate your calculations.