Sell or retain investment property

Hi

I'm debating whether or not to sell an investment property. The details are as follows:

Value €300k
Rent €18,000 pa
Mortage €200k
Interest rate 0.5%
Revenue items (including tax) €10k pa
Net income €8k pa
Repaying €12k capital pa
Paying 3.1% on home mortgage
No other debt and no scope for AVCs

My sense is that I should not sell it, but it's a decision that I circle back to periodically.

Thanks in advance.

Hi Gordon

Your rental is currently cash-flow negative to the tune of €4k pa and you currently have €100k of capital tied up in the property. One way of framing this question is asking whether applying those funds against the balance of the mortgage on your PDH would be a better use of your capital/income.

I assume you are maxing your pension contributions and have no liquidity concerns.

Paying down the PDH mortgage would result in a tax-free net return equivalent to 3.1% pa - so that's the headline number to beat. The gross yield on your rental is currently 6% pa but after taxes and expenses it falls to 2.66%. That's less than 3.1% so, on the face of it, selling the rental and re-directing the €100k (plus €4k pa negative cash-flow) to pay down the mortgage on your PDH would appear to make sense.

That obviously ignores future rent and house price inflation/deflation, the age of the property (ie whether maintenance costs are likely to accelerate in the near future), possible changes to the tax code, future mortgage rates, etc.

It's clearly a close call either way.

If it was me, I'd probably opt to take some risk off the table and sell the rental, while maintaining an aggressive stance within your pension fund. However, I'm positive others would (quite legitimately) arrive at the opposite conclusion!

Thanks Sarenco. Sensible stuff as always.

Is my net annual return 2.66% or 8% though? i.e. my sense is that the former ignores the impact of the gearing. My skin in the game "only" amounts to €100k at the moment, but that profile is obviously changing constantly, which should change the analysis. Or am I missing something obvious in my analysis?

Many thanks.

I think the correct yield from the rental is 8%, that is €8k over the €100k value of your investment. Reason enough to hold the property, if ou can continue to fund the cash-flow requirement.

I also think that this is less important than the capital position. Due to the gearing every 1% increase or decrease in the value of the property gives you a 3% return or loss.

No one can tell you whether property prices will rise or fall, but that does not mean that your exposure to loss or gain is symmetrical.

Assuming again that you are able to fund the cash-flow, if the capital position improves you can crystallise a gain, but if it disimproves you do not need to crystallise the loss.

To put numbers on it, if the property is worth €320k in 2 years time, you can sell and make 20%, if it is worth €280k, you can keep collecting your 8% return and wait for the price to recover.

I don't think you could possibly get as good an opportunity elsewhere. My advice is keep it.

Gordon Gekko said:

Is my net annual return 2.66% or 8% though? i.e. my sense is that the former ignores the impact of the gearing.

Click to expand...

Hi Gordon

You are quite correct - 2.66% is the simply the net yield on the asset after tax - it ignore the impact of leverage. The "cash on cash" return is 8% - the 2.66% return leveraged by a factor of three.

I deliberately ignore leverage to get to a number that's comparable to the financial return on paying down the PDH mortgage from a risk/return perspective. In other words, I'm trying to assess which is the better investment on a risk-adjusted basis.

Critically, the 2.66% figure also ignores capital gains/losses, which is obviously a key element of the total return on the asset and will be amplified by the degree of leverage employed.

Hope that helps.

1) Cash flow is not a problem for you, so it's not relevant to your calculations
2) Discussion of yield is confusing and is very hard to follow.(In other words, I don't follow those calculations, and they may be right or wrong.) It's also easy to make a mistake.

That is why I recommend just doing the numbers. If I make a mistake in them, they are very easy to spot and correct.


Current situation worth €300k with mortgage of €200k



This assumes that you can pay the full €100k off your mortgage and so get a 3.1% return on your money.

As with any investment decision, you have to judge the future outlook for capital appreciation, rent and interest rates.


"My sense is that I should not sell it, but it's a decision that I circle back to periodically."

Let's do that - fast forward a few years - same value but mortgage reduced to €100k



The key assumption is that you are able to repay the €200k proceeds off your mortgage.

If you no longer have a mortgage, then you are getting a net return after tax of €5,500 on an investment of €200k.

It really would depend on your view of the markets at that stage. I have a preference for the stock market over property, but if you felt that the stock market was overvalued and property was fairly valued, then you would keep the property.

Brendan

Are there CGT factors to be considered?

If you realise a taxable gain, then your investment is less than €100k.

If it's worth less than you paid for it, then you should probably keep it as any increases in value to the price you paid are free of taxes. ( Of course, you could use the loss for CGT purposes against later gains)

If it was formerly your PPR, and there is a capital loss, I think it's even more worth keeping as any increases are free of CGT.

cremeegg said:

No one can tell you whether property prices will rise or fall, but that does not mean that your exposure to loss or gain is symmetrical.

Assuming again that you are able to fund the cash-flow, if the capital position improves you can crystallise a gain, but if it disimproves you do not need to crystallise the loss.

To put numbers on it, if the property is worth €320k in 2 years time, you can sell and make 20%, if it is worth €280k, you can keep collecting your 8% return and wait for the price to recover.

Click to expand...

That sounds really interesting, but I don't really understand it.

Does it assume that rents won't fall? Does it assume that prices will increase in the long-term or at least before Gordon has to sell it?

Brendan

I have assumed throughout that you are not overexposed to property and borrowing on your PPR?

If you have a home worth €800k and a mortgage of €800k and a salary of €100k, then definitely take risk off the table and sell the property.

If you have a home of €800k and a mortgage of €400k and a salary of €200k, then you do not need to take any risk off the table, when the return is so good on the property.

Brendan

The property was my PPR for quite a while and is still underwater in any event, so I have a potential tax-free gain on the upside.

The current PPR is manageable in terms of LTV and LTI...circa 60% and 3.5 times.

Brendan Burgess said:

That sounds really interesting, but I don't really understand it.

Click to expand...

Hi Brendan

I think Cremeegg is simply making the very valid point that, in addition to the super low rate, the mortgage on the rental is non-callable so the bank can't force Gordon to sell after fall in value, simply because the value of its collateral has fallen.

The fact that mortgages are generally non-callable is one of the real advantages of leveraging a real estate investment compared to buying stock on margin. One of the key aspects of successful investing is to avoid being a forced seller at precisely the wrong time.

Gordon Gekko said:

The property was my PPR for quite a while and is still underwater in any event, so I have a potential tax-free gain on the upside.

Click to expand...

OK, that would probably swing it for me. Most other investments are subject to CGT.

Even after it recovers to the price you paid for it, the effective CGT rate is reduced as it was your PPR for quite a while.

My default approach would be to sell and invest the proceeds in equities. But with a cheap tracker and a CGT free investment, I would hold onto it.

Brendan

Brendan Burgess said:

That is why I recommend just doing the numbers. If I make a mistake in them, they are very easy to spot and correct.

Click to expand...

Hi Brendan

Your figures really bear out my key point that paying down the PDH mortgage "wins" if you take leverage out of the equation (or substantially reduce the gearing factor). I prefer to think in terms of ratios but ultimately you get to the same place.

I think we can all agree that adding leverage to the mix increases risk as the bank will still expect to get paid even if the tenant defaults. The question then becomes whether the additional expected return justifies taking the additional risk? Using your figures, whether the risk is worth an expected (but not guaranteed) additional ~€2k pa (+/- any capital gains/losses)?

That's obviously a judgment call and it depends on Gordon's ability, need and willingness to take that risk to achieve his financial goals.

The fact that any potential capital uplift would be tax-free (to a point) is certainly attractive but I don't think it fundamentally changes the analysis.

Brendan Burgess said:

1) Cash flow is not a problem for you, so it's not relevant to your calculations
2) Discussion of yield is confusing and is very hard to follow.(In other words, I don't follow those calculations, and they may be right or wrong.) It's also easy to make a mistake.

That is why I recommend just doing the numbers. If I make a mistake in them, they are very easy to spot and correct.


Current situation worth €300k with mortgage of €200k

View attachment 1538

This assumes that you can pay the full €100k off your mortgage and so get a 3.1% return on your money.

As with any investment decision, you have to judge the future outlook for capital appreciation, rent and interest rates.


"My sense is that I should not sell it, but it's a decision that I circle back to periodically."

Let's do that - fast forward a few years - same value but mortgage reduced to €100k

View attachment 1539

The key assumption is that you are able to repay the €200k proceeds off your mortgage.

If you no longer have a mortgage, then you are getting a net return after tax of €5,500 on an investment of €200k.

It really would depend on your view of the markets at that stage. I have a preference for the stock market over property, but if you felt that the stock market was overvalued and property was fairly valued, then you would keep the property.

Brendan

Click to expand...

Hi Brendan

The net return is €8k rather than €5k.

This discussion has reinforced my own view. The €3,100 of interest which could be saved on the PPR will grow as my equity in the investment property grows. At the moment, it makes sense to retain the investment property, but at some future point, the position will change, notwithstanding the CGT shelter.

Gordon Gekko said:

The net return is €8k rather than €5k.

Click to expand...

OK, I wasn't sure what this meant

Revenue items (including tax) €10k pa

I had assumed that it was 50% Income Taxes and Local Property Tax.

Brendan

Brendan Burgess said:

OK, I wasn't sure what this meant

Revenue items (including tax) €10k pa

I had assumed that it was 50% Income Taxes and Local Property Tax.

Brendan

Click to expand...

Ah...I see. No, in cash terms I pay out €10k (including my tax liability), which leaves me with €8k.

Lord knows how property investments are supposed to work with an interest rate of 4.5%.