Index investing vs renting out real-estate for Belgians

Leverage: the main benefit of real-estate investing

Leverage, that is borrowing money to invest, can be a powerful tool to increase your return. The theory states that as long as the cost of borrowing is lower than the potential return, you’re always better off by taking on a loan. Furthermore, the higher the leverage, the better as this increases your overall profitability. 

Imagine putting €20,000 in an investment that has a return of 4%. After one year, you will have a profit of €800.

Now, let's say you’re putting in €10,000 of your own money and borrow the remaining €10,000 at a rate of 2%. After one year, your investments will still earn a profit of €800. You have to pay €200 in interest on the loan, leaving a net profit of €600. But since you put in only €10,000 of your own money, your return is 6%. By borrowing part of your investments, you increased your return from 4% to 6%.                       

Real estate investing relies on the same principle: you boost the return on your investment by taking on a mortgage. And ideally, the interest on the loan is paid for by the renter. What does this look like when computing the numbers?

Buying a property with €70,000 of capital or... 

Let’s assume you own the place where you live. You want to invest in a second property, spread over 20 years. You are looking to buy a two-bedroom apartment that isn't new, but which doesn’t require any renovation, in a building in Brussels. The purchase price is €350,000 excluding tax. The bank requires 20% as a downpayment, or €70,000. For the sake of this article, we will assume that you have that amount at your disposal. When you include the recording rights and notary fees, the price of the property increases to €398,300. This means you have to take on a €328,300 mortgage to cover the difference. Based on our research, you are able to get a rate of 1.38% over 20 years. 

Now, let’s get a clear view on our investment. Explore our spreadsheet to play around and adapt as you wish.

• Lump sum €70,000
• Price of the property €350,000 plus tax (recording rights and notary fees) which is approximately €398,300 
• Required loan: €328,300 at 1.38% fixed rate for 20 years. This equates to €1,574.72 per month to pay back, or €18,896.64 per year

Renting out the property 

Based on estimates from the real estate industry, we expect a gross return of 4.5% from the rent. For a €350,000 investment, you’d get approximately €15,750 yearly, or €1,312 a month. Bear in mind that this number doesn’t take into account:

• yearly maintenance fees
• insurance
• property tax (“précompte immobilier” or “onroerende voorheffing”)
  

From our research and after talking to real estate agents, you can expect to spend around 1.5 months of rent to cover those costs, reducing your return to around 3.9% net. This means approximately €13,790 a year, or €1,150 a month.

On the flip side, the rent is indexed on a yearly basis. The average indexation of renting price is 1.73%. 

As the mortgage payment (€1,574) is higher than the expected net rent (€1,150), you will have to add money each month on top of the rent to pay back your mortgage. Taking into account the indexation of rent, we calculated that over 20 years you will have to add €51,940 to pay for your mortgage.

Selling the property in 20 years

Between 2005 and 2021, house prices have increased an average of 4.2% per year. This means that 20 years from now, our flat that we purchased for €350,000 will be worth about €800,000. As a consequence, your overall return would be: 

• Total capital put at work over 20 years: €121,940 (starting capital of €70,000 + €51,940 sum of the monthly additions to cover your mortgage)
• Selling price in 20 years : €800,000
• Annualized return on investment : 9.86%

...investing €70,000 into a portfolio of index ETFs

Now we're going to compare these numbers with investing in the financial markets:

• €70,000 as a lump sum
• Yearly contributions equal to the amount of €51,940 over 20 years (sum of our monthly top ups to cover our mortgage) 
  

We invest in a globally diversified portfolio of index funds of 70% stocks and 30% bonds. A historical analysis tells us that such a portfolio has earned an average annual return of 7.9% between 2005 and 2020. From our calculations which can be found in our spreadsheet, in 20 years from now you would have saved approximately €480,000.

Conclusion: investing in real estate wins

• Property investment value in 20 years : €800,000
• Index ETF investment value in 20 years : €480,000
  

Note that these numbers are estimates based on historical data. We have no guarantee that the next 20 years will play out like they have in the past.

Leverage really works

This simulation showed us that the leverage effect is powerful and probably the reason why so many people invest in properties. It also showed that you can increase your overall return by increasing your leverage.

The complexities of investing in property

While many Belgians consider real estate a safe and sound investment, we realised that it isn’t easy to be successful at it. Indeed, you can’t just pick any property on any website and use the highest leverage possible to be assured that you have made a good investment. In this section, we’ll run through all the considerations that have to take place.

Location, location, location

We discussed with many experienced real estate investors, and they all said the same: location is key. For example, properties that are walking-distance from shops, grocery stores and means of transportation (metro, train stations, bus stops, etc.…) are more attractive and are less likely to remain vacant.

We also found out that cities, such as Brussels or Ghent for example, are locations which gather the highest number of renters (70% for Brussels and 67% for Ghent). This is therefore very attractive for investors and has enabled rent prices as well as property prices to increase dramatically over the years. These prices, however, vary sharply across regions, which confirms the importance of choosing the right location according to your objectives.

A house? An apartment? A serviced residence?

The type of property is another important factor to consider if you want to be successful in real estate investing. For example, is a three-bedroom house with a garden or a two-bedroom flat a better investment?

We started by comparing price trends between different types of properties in Belgium. According to Statbel, the Belgian Office for Statistics, median prices in Belgium have increased by 5.0% for detached houses and 7.4% for apartments from 2019 to 2020. 

So apartments seem like a better investment. But on the flip-side, they have additional ongoing fees. Because you become part owner of the building, you must constitute a current account for regular expenses. Furthermore, you're required to participate in a reserve fund for major expenses such as building renovations. 

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New or renovate

Mathieu, one of the real estate agents we talked to working for a well-known real estate agent in Brussels, had the following interesting insight:  

When you’re buying a property as an investment, you need to keep in mind that you won’t live there, so you have to put yourself in the shoes of someone willing to rent. That means you have to think pragmatically. You don’t care if the kitchen is painted in a color that you don’t like, or if the bathroom doesn’t have a marble sink. Look for long-lasting materials that do not require a lot of maintenance and functional spaces, which would suit the majority of potential renters. 

These comments let us touch upon another aspect of buying a property: should we buy something new or something to renovate? A property that needs renovation is cheaper than a new building. Indeed, on top of a cheaper purchase price, there are many fiscal incentives for second hand buyers, such as a reduced 6% VAT on renovations compared to the regular 21%.

However, renovating requires knowledge: 

1. Before buying the property, you must estimate the works that need to be done.
2. You must pick builders that can be trusted and make sure prices are in line with the market. 
3. You can’t rent until you’ve actually finished renovating. 
   

All of this is time consuming and has an impact on your overall return on investment, impact which is hard to quantify beforehand. With a new building, no renovations are needed and they offer an energetic advantage, which is a factor that has gained importance in rent and selling prices. 

Fiscal aspects

VAT versus recording rights

When buying a property, you need to consider purchase taxes and fees. 

On all buildings that aren’t new, the buyer has to pay as recording rights:

• 10% in Flanders
• 12.5% in Wallonia and Brussels 
  

On top of this, 1.3% will go towards notary fees. This increases the price of existing buildings by more than 10%. 

For new buildings, a VAT of 21% is applicable. However, under certain conditions, the buyer can benefit from a reduced VAT rate at 6%. This measure has been put in place to encourage potential homeowners. There are no recording rights for new properties. 

Taxes on capital gains

When you sell a property as a private individual, you’re not taxed on the capital gains if you’ve owned it for more than 5 years. However, this rule doesn’t apply if you invest through a company or in the case your investment is considered as “speculation”.

Taxation on rental and personal income  

An interesting feature of real estate is that the rental income isn’t taxed between private individuals (things change when investing through companies or for commercial buildings). Does this mean that buying a property is tax efficient? Well, yes and no. 

In fact, secondary property owners are taxed on the cadastral income ("kadastraal inkomen" or "revenu cadastral"). In theory, it’s the estimated rental income of a building on an annual basis, excluding maintenance or repair costs. In the case of an apartment, 40% of the estimated rental income can be deducted from the rent as a lump sum. Fortunately for us, when buying a property to rent out, the rent prices from 1975 are still taken into account!

This revenue is included in the overall income and therefore taxed on your personal income tax bill. On top of this, secondary homeowners lose the so-called “sole and own house” fiscal advantage ("habitation propre et unique" or "enige en eigen huis"). This tax credit amounts to a maximum of €1,520 per person.

There is, however, a way to get around this: it is possible to reduce this tax by deducting the interests you pay if you take on a mortgage. This last point is essential, and also explains why leverage is often used.

The risk of using leverage

One of the first things that comes to mind when using leverage is that you need to be able to afford a loan and repay your mortgage no matter what. This can be problematic if, for example, you have the misfortune of losing your job or when you're struggling to find renters. Ultimately, the bank will decide how much and for how long they’ll lend you the money needed for your investment, which again has an impact on your overall return.

Investing in index ETFs is (relatively) simple

On the other side of the story, it seems that investing in index ETFs provides an easy way to save and invest for the future. You can even invest in ETFs that focus on real estate. While the complexities of index investing lie in getting started, things get pretty simple once you’ve figured out the right ETFs that match your needs:

• Index investing requires little knowledge
• Index investing offers diversification across assets, geographies and sectors;
• Index investing is cheap and doesn’t require a minimum capital to start
• Index investing is "liquid", meaning you can tap into and pull out whenever you want
• You can adopt a disciplined approach to savings, by putting your investments on autopilot through monthly contributions

Conclusion

One of the key takeaways from our simulation is that you need to think rationally and leave out any emotions from your decision-making. While this is true for both types of investments, it's harder to be rational with property investing, because you're buying a place you yourself could live in. It's easier to get carried away by your own wishes and emotions. 

The power of leverage can make renting out a property a better investment than putting your money into index funds. The benefits are clear:

• Rental income as well as capital gains aren’t taxed (yet)
• You can deduct mortgage interest payments from your personal tax bill
• Leverage through a mortgage is a powerful tool to boost your return
  

However, in order to be successful, investing in a property requires methodology and thorough analysis:

• Investing in real-estate requires knowledge
• Investing in real-estate requires time for maintenance
• You need a starting capital to make the initial purchase
• Rental vacancy risk is an important factor to be considered. At the end of the day, it is a less serious issue not to be able to top up your index fund than not knowing how to pay back your mortgage.
• Investing in a property isn’t liquid compared to index investing. You can't sell a fraction of a house, but you can sell a single share of your index fund.
• Investing in properties is more subject to micro events such as changes in taxes. This is especially true in a country like Belgium that is known for its fiscal uncertainties.
  

We’ve shown that it’s more time-consuming, complicated and riskier to invest in property than investing in index funds. However, the historical data and our simulations have shown that real-estate investing is expected to be a better investment than index funds. Make sure to cover your mortgage payments if you do decide to purchase another property. Also, continue forming the habit of putting money away by passively investing it on the side to grow your nest egg and gain diversification.

Resources

The following resources helped us put together this article:

• La localisation, point déterminant pour un bien d’investissement
• Prix de l'immobilier
• Indice des prix des logements
• Cinq questions à se poser avant d'acheter un appartement
• Notaire.be
• TVA à 6 % pour la démolition et la reconstruction
• Pouvez-vous déduire l'emprunt de votre bien d'investissement?
• Les crédits qui peuvent faire baisser la facture fiscale de votre immobilier
• Mon investissement immobilier a-t-il un bon rendement?