Tax take on rental income is staggering

[Gerard123]

I ran a calculation to see what the cost is to a private individual of providing a rental house in Ireland and the results were eye opening, and shocking. No wonder landlords are leaving the market and rents are spiralling.

Assumptions:

House cost 300k, int rate 4%, marginal tax rate 50%. Monthly rent 1,600, 25 year mortgage. Net rent (gross less maintenance, outgoings, expenses, but before mortgage)= 75% of gross.
300k mortgage @4% costs 1,585 per month over 25 years. For simplicity - 0% inflation and no change in interest rate.

Scenario 1 - as above. Based on present system it would cost a private individual about 230k to fund that BTL over 25 years. At the end they would own the house, making a return of net 70k (300-230k). It would be far better to simply invest that 230k in a bank deposit accounts for 25 years!

Scenario 2 - what would the monthly rent need to be to support buying a BTL based on above assumptions. Incredible that it seems (but accurate), I calculate that rent would need to be 3,650 monthly to finance the purchase (i.e. the rent would need to increase by 128%). This sounds incredible but when you break it down here are the numbers: Over the 25 year period - net rent 821k, mortgage interest 174k, taxes 345k. And that does not take account of the taxes on the house build/cost, stamp duty or any VAT paid on repairs and outgoings over the 25 years.

The Govt and Departments have done a 'good'(??) job at attempting to divert attention away from tax policy as being a fundamental reason for the dire state of the rental market. The numbers speak for themselves.

Conclusion - one of the main reasons, if not the main reason, why the rental market is in such a dire state is the high level of taxes that private landlords are required to pay and the Govt tax take generally from house transactions and rentals.

 

[T McGibney]

I did a similar exercise earlier this year for a high-rate taxpayer considering a €230k purchase, and €170,000 mortgage to be repaid over 25 years, with a decent rent roll.

I discovered their overall effective tax rate in year 1 was well over 70% and equated to 68.5% on average over a 25 year horizon if the tax system doesn't change in the meantime.

Your own calculations relate to a different scenario and arrive at an effective tax rate of 42%. I don't know if this relates to a standard- or high-rate tax payer.

Either way, the conclusions are still staggering.

 

[Gerard123]

Top rate tax payer, I assumed marginal tax rate 50% (in practice is a little higher I know with USC and PRSI). Overall results either way are staggering. The tax take on rental properties is enormous.
Out of curiosity how did you get to a 70% in year one as marginal tax if the actual rates are 40%, plus USC and PRSI? I don't understand.
Thanks.

 

[T McGibney]

Out of curiosity how did you get to a 70% in year one as marginal tax if the actual rates are 40%, plus USC and PRSI? I don't understand.
Thanks.

25% of mortgage interest not allowed.
Capital allowances not allowed against USC (can't recall offhand if allowable against PRSI).

 

[Sarenco]

Conclusion - one of the main reasons, if not the main reason, why the rental market is in such a dire state is the high level of taxes that private landlords are required to pay

Strongly agree with this conclusion.

I find it strange that media commentators rarely draw the link between the rapacious level of taxation on rental income and the current rental/homelessness crisis. It really should be obvious when you work through the figures.

However, what is most worrying is that the Government seems to be pursuing a deliberate policy to institutionalise the residential letting business by making it almost impossible for private individuals to compete with (largely tax exempt) property funds and REITs.

In my opinion this policy is completely wrong-headed.

It seems to be based on the assumption that a diverse, private landlord base is incompatible with secure, long-term letting arrangements and Germany is regularly cited as a shining example in this regard. However, it's a total myth that German landlords are predominantly financial institutions - in fact 80% of landlords in Germany are private individuals (source: LSE comparative study).

The real reason that long-term letting arrangements are uncommon in Ireland is simply down to tenant preferences - it has nothing to do with the nature of the landlord base.

 

[AlbacoreA]

While tax is perhaps one of the main issues, for LL leaving the market its not the only one.

The Govt inaction, (or strategy) here is risky. There is no reason to believe large property investors will come in and rent the property they buy. Like Nama they may simply sell it, and or sit on it.

 

[Joe_90]

The issue with the tax is one but I think the yield is just too low in these cases.

You are proposing to borrow money at 4% and have costs of 25% of the gross rent.

So the rent is €1,600 x 12 = 19,200.
The costs are €19,200x 25%=4,800
Interest yr1 12,000
Money available €2,400 to pay back capital. Capital repayment in year 1 €7,020.

At a gross yield of 6.4% it simply does not stack up if you have to borrow and have those costs.

 

[Gerard123]

I agree that the gross yield is certainly a little low, however long term in a balanced market one might expect a gradual increasing of rents.
Landlords can/should be able to partly finance the mortgage (else they probably should never have bought?). Sympathy is diluted a bit for landlords who entered the market as a bit of a gamble ('everyone was doing it' type attitude, they weren't!), no experience, didn't run the numbers, didn't build in contingencies, etc. Individuals have responsibility for their own actions.

Landlords can also seek to actively manage the property, limit vacancies, focus on costs, do some of the maintenance work themselves with a view to managing cash flows. These all help. However, when it comes to tax there is nothing that can be done to manage that cost and I believe that excessive tax is the tipping point for many people. Also the constant changing of the rules mid stream brings in a lot of uncertainty and makes long term investing for many people impossible in this space.

In the previous post tax would amounts to around 3 grand in year one, on top of the need to fund the capital payments. The latter can be considered long term savings, its not 'dead' money. Its excessive tax and changes in the rules that make things different and difficult.

I also find it naïve (comical if it wasn't so serious) the way the media, particularly, cite that buying is cheaper than renting, without comparing apples and apples. They simply compare monthly rent versus mortgage payments. No mention of costs of owning the house, insurance, property tax, repairs, maintenance, etc.

In half a generation private landlords will be wiped out/reduced. Large institutional investors and overseas funds will have control of the rental market. There won't be too much tax then from the rental sector. How much better off then when they can dictate to the Govt, just like we see in other sectors.

 

[trasneoir]

House cost 300k, int rate 4%, marginal tax rate 50%. Monthly rent 1,600, 25 year mortgage. Net rent (gross less maintenance, outgoings, expenses, but before mortgage)= 75% of gross.
300k mortgage @4% costs 1,585 per month over 25 years. For simplicity - 0% inflation and no change in interest rate.

Scenario 1 - as above. Based on present system it would cost a private individual about 230k to fund that BTL over 25 years. At the end they would own the house, making a return of net 70k (300-230k).

[Scenario 1a] It would be far better to simply invest that 230k in a bank deposit accounts for 25 years!

I'd start from the general position that unless a landlord is bringing labor or equity to the table, the market shouldn't be rewarding him with a profit. Our tax policy should discourage any situation which would allow punters to turn pure risk into profit, especially where we're protecting the punters from the downsides of that risk (reposession). If you look at your scenarios from the perspective of what you (rather than the bank) are bringing to the table, the numbers make more sense.

You can't ignore capital growth. Allowing for a conservative 1% growth in the property's value, your property is worth 385k after 25 years, so your net return would be closer to 70k + (85k*.67) = 132k.

You can't ignore the time value of cash. €900 per month over 25 years (Scenario 1) is worth a lot less than 230k in your hand today (Scenario 1a).
- At 2.75% interest (after tax), your (Scenario 1) 900 per month would amount to 385k after 25 years.
- At 2.75% interest (after tax), a (Scenario 1a) 230k lump sum would amount to 450k.

 

[trasneoir]

The real reason that long-term letting arrangements are uncommon in Ireland is simply down to tenant preferences - it has nothing to do with the nature of the landlord base.

Hang on. My understanding is that there's no way (here) for a landlord and tenant to agree a binding long-term lease with proper protections for both parties?
How can we establish that there's no demand for a product if it's never been available (here)?

 

[Sarenco]

Hang on. My understanding is that there's no way (here) for a landlord and tenant to agree a binding long-term lease with proper protections for both parties?

Of course there is - landlords and tenants are free to agree whatever terms they want and there is a sophisticated legislative framework of protections.

The reality is that most tenants don’t consider long leases because deep down they consider themselves to be latent buyers that are simply biding their time until they are in a position to "get on the ladder".

 

[trasneoir]

The reality is that most tenants don’t consider long leases because deep down they consider themselves to be latent buyers that are simply biding their time until they are in a position to "get on the ladder".

I take your point, most tenants probably do think this way. Why wouldn't they, they've never been exposed to the alternatives.
If the legal picture for long term leases is totally benign, why don't most/all landlords offer them as an option? Wouldn't they save on vacancy, advertising and viewing costs?

 

[Logo]

Thanks Gerard123 and others for making such valid points. While watching the Vincent Browne show and listening to Matt Cooper radio show someone else attempted to make these points - but even as a landlord I felt unconvinced.

 

[Sarenco]

If the legal picture for long term leases is totally benign, why don't most/all landlords offer them as an option? Wouldn't they save on vacancy, advertising and viewing costs?

Absolutely - long leases should be a "win/win" for both landlord and tenant for exactly those reasons.

Karl Deeter made these exact points on his blog recently -
[broken link removed]

I've no doubt that most residential landlords would be thrilled if tenants agreed to multi-year tenancies with regular rent-reviews, etc. However, there is no point offering a product or service if your customers don't have any appetite for that product or service.

It's a shame really.

 

[T McGibney]

I've no doubt that most residential landlords would be thrilled if tenants agreed to multi-year tenancies with regular rent-reviews, etc. However, there is no point offering a product or service if your customers don't have any appetite for that product or service.

It's a shame really.

It's taken very generous tax exemptions to tempt landowners into long-term land rental agreements to farmers. They seem to be working as they were extended in the Budget 2/3 years ago.

 

[Gerard123]

I'd start from the general position that unless a landlord is bringing labor or equity to the table, the market shouldn't be rewarding him with a profit. Our tax policy should discourage any situation which would allow punters to turn pure risk into profit, especially where we're protecting the punters from the downsides of that risk (reposession).

Agree with that. Neither policy nor easy lending should promote risk. Did all landlords really seek to turn pure risk into profit? For some people sure, but I don't think the majority did.

However, what about the alternative that is being promoted, is it really any better or lower risk? Funds, including foreign, investing other peoples money, borrowing etc. I would say that much of the investing by funds is much higher on the speculative risk scale and seeking to turn pure risk into profit. The second that the returns dry up they will be gone. As tax payers will we have to bail them out also? Be careful what you wish for. Bailing out banks has cost a lot more than bailing out a few landlords.

Not so sure that policy is preventing repossessions for landlords, it certainly should not be, though there has been a hesitancy. Partly by the banks themselves who were slow to pursue some repossessions as it would have crystallised losses for them. Landlords remain on the hook for the balance, some may go bankrupt but most struggle on for years, rather than go down that route.

You can't ignore capital growth. Allowing for a conservative 1% growth in the property's value, your property is worth 385k after 25 years, so your net return would be closer to 70k + (85k*.67) = 132k.

You can't ignore the time value of cash. €900 per month over 25 years (Scenario 1) is worth a lot less than 230k in your hand today (Scenario 1a).
- At 2.75% interest (after tax), your (Scenario 1) 900 per month would amount to 385k after 25 years.
- At 2.75% interest (after tax), a (Scenario 1a) 230k lump sum would amount to 450k.

Difficult to build in every scenario though there are other factors. My workings were estimates, though based on experience over a 15-20 year period and well informed IMO. Appreciate its easy to pick holes in my or indeed any workings.

Capital growth if it happens? Many properties will be doing well to escape negative equity when the mortgages are paid. I have always worked on the assumption that an investment in property should assume no capital growth as a starter. It should be forecast on the basis of affordability and cash flows. If an investment doesn't make sense on the basis of cash flows and needs capital growth to support it the risk significantly increases. And where is the cash flow going to then come from? Once that is done by all means consider the implications of capital value changes.

In my workings inflation and interest rate changes take care of the time value of money, that's what the time value of money is in simple terms.

Hope this explains.

 

[trasneoir]

However, what about the alternative that is being promoted, is it really any better or lower risk? Funds, including foreign, investing other peoples money, borrowing etc.

Most funds can't borrow.
REITs can borrow, but only up to 50% of their assets.
It seems like many if not most individual BTL investors carry debt in the 80-120% range.

I would say that much of the investing by funds is much higher on the speculative risk scale and seeking to turn pure risk into profit. The second that the returns dry up they will be gone.

Funds bring their shareholders' money to the table, so the risks and rewards ultimately rest with them. As long as the risk is borne by private money rather than state-backed banks, I'm happy enough.

The second that the returns dry up they will be gone.

That's fine. They'll sell their properties for whatever somebody else is willing to pay, and life will go on.

 

[Sarenco]

Most funds can't borrow.

Sure they can - it's not at all uncommon for property funds to be highly leveraged.

REITs can borrow, but only up to 50% of their assets.

That's certainly true of Irish REITs. Bear in mind that REITs don't get a tax deduction for interest payments - because they don't pay tax! - so they have less incentive to borrow against their rental properties.

They'll sell their properties for whatever somebody else is willing to pay, and life will go on.

And in the meantime the State will forego a serious amount of tax...

I don't have a problem with incentivising institutional investors to invest in Irish assets. My problem is that it this seen by our Government as some sort of panacea for our housing problems that cannot be provided by private investors.

 

[Gerard123]

Most funds can't borrow.
REITs can borrow, but only up to 50% of their assets.
It seems like many if not most individual BTL investors carry debt in the 80-120% range.

Source please? Some - Yes. Most - No.

Funds bring their shareholders' money to the table, so the risks and rewards ultimately rest with them. As long as the risk is borne by private money rather than state-backed banks, I'm happy enough.

Who are these shareholders? Private individuals ultimately in some form, be it direct (eg geared property funds) or via a fund or pension, etc. Much of this was borrowed and resulted in the bailouts being needed. One can't simply distinguish shareholders as if they hold funds outside the system, invest and if its lost its lost, and at no cost to the taxpayer. Bailouts unfortunately suggest something very different. (Not meaning to divert the post but the very same is/was said about insurance companies carrying the risks and bearing the costs. We have all seen what happens when things go wrong, bailouts, levies, etc - taxpayer and citizens pick up the tab, not the shareholders).

I will repeat what I said earlier, the vast majority of bailing out the banks was not for private landlords, rather speculative funds and investments made by banks, institutions, etc. Ultimately it was Irish State money that bailed many of these losses made by or on behalf of so called shareholders. (From what I saw the share part of the name only applied to upsides and profits).

I was highlighting the staggering tax take on rental properties owned by private individuals in Ireland and the different treatment REITS and overseas funds are subject to.

I don't think anything I said takes away from what appears to be your theme which is towards sensible investment, manage risks, risk bearer should take the losses, etc. Agree with all of that.

 

[SDMXTWO]

If I could just drop in this question rather than a new thread.

Unfortunately our parents house will be empty in two to three years max. House worth 400k and is rentable for 1900pm. Would you sell or rent the property?