# Accidental landlord-calculating yield



## jobseekr1 (3 Feb 2015)

How do I figure out if the rental income is a good yield?
Basic sums are possible rental income of 520ish and mortgage of 325 per month.
It’s a tracker mortgage, low interest rate. 24 years left on it. 1% interest rate.
Just trying to weigh up to sell or keep.


----------



## Brendan Burgess (3 Feb 2015)

Hi j

I wrote a Key Post which sets out the issues. 


Should I sell my home in negative equity or rent it out?

I suggest, that you read this.  And then crunch out the numbers and post them here for others to review. 

But it's a good general guide that if you have a cheap tracker, you try to keep it.

You describe yourself as an "accidental landlord".  If you are with a live lender, they will allow you move the tracker to a new home. If you are with Danske or BoSI , they won't.

Brendan


----------



## Sarenco (3 Feb 2015)

The gross yield is the annual anticipated rental income, expressed as a percentage of the current fair market value of the property (i.e. €6,240 (€520 x 12) divided by your best estimate of what sales price the property is likely to achieve in the current market, multiplied by 100).

To arrive at a net yield figure, I would recommend that you reduce the anticipated annual rental income by at least 25% - 33% to be conservative.

The 25-33% reduction to arrive at the net yield figure is intended to reflect the average annual expenses of holding a rental property.  Expenses include management/letting agent fees, insurance, repairs & maintenance, replacing white goods and furniture, PRTB, LPT, refuse disposal, OMC annual management fees (if applicable) advertising, legal, accounting, etc.  The 25-33% reduction also captures all imputed costs including voids (i.e. the time between tenancies), over-holding periods (i.e. where a tenant stops paying the rent but does not leave the property) and your own time costs if you manage and/or maintain the property yourself and/or prepare your own tax returns.  Annual holding costs will obviously vary from year to year and the 25-33% reduction of anticipated annual rental income represents the average over a long-term holding period based on my own experience.

Financing costs (i.e. your mortgage rate) has nothing to do with calculating the yield on a property.

In my personal opinion, a gross yield of 6% (reflecting a net yield of 4-4.5%) on a single rental property is the absolute minimum that makes sense as an investment in the current environment.  In other words, if your property would sell for €104,000 or more then I would recommend selling it (assuming obviously that you can fund any shortfall on any outstanding mortgage).

There are a number of other issues that should be considered when deciding whether or not to retain a rental property (including your mortgage rate, your income tax position, whether you hold a diversified portfolio of other assets and whether you have sufficient cash reserves to maintain the property) but in my opinion the yield calculation is the single most important consideration.


----------



## Brendan Burgess (3 Feb 2015)

Asking "What is the yield on this property?" is the wrong question. 

The only question is "Should I sell this property or rent it out?" 

Take a property worth €100,000 owned free of any mortgage. The yield is 6%.  
Take a property worth €100,000 with a €100,000 tracker on it at 1%. 
The profit is €5,000 a year on an investment of zero. 
The yield, infinity, is meaningless in this case. 

Brendan


----------



## Sarenco (3 Feb 2015)

Brendan Burgess said:


> Asking "What is the yield on this property?" is the wrong question.
> 
> The only question is "Should I sell this property or rent it out?"
> 
> ...



Brendan

I might be on my own on this one but I am strongly of the view that determining a realistic view of the potential net yield on a rental property is absolutely key to determining whether to acquire (or retain) that property.

Taking your first example, a property worth €100k owned free and clear with a gross yield of 6 per cent will give you a pre-tax profit of €4,500 (using a 25 per cent expense ratio) per annum on an investment of €100k.  Pretty straight forward.

Your second example appears to refer to a 100 per cent mortgage at a current rate of 1 per cent that is never repayable.  Even at the height of the madness I don't think anybody was lending money on that basis.  If they were, then yes, retaining a rental property with a net yield of anything above 1 per cent is an obvious no brainer (leaving income tax aside).

I don't think that is the point you are making but you might clarify as it seems to me that it is key to clarify the concepts of capital investment, financing, cash-flow and profit as these issues seem to be conflated in a number of recent threads.


----------



## Brendan Burgess (3 Feb 2015)

Sarenco said:


> Even at the height of the madness I don't think anybody was lending money on that basis.



BoSI gave cheap trackers on an interest only full term basis.  Madness, maybe. But they did it.

But the same principle applies to repayment mortgages also. If the OP has a property worth €100k and a mortgage of €100k, or thereabouts, then usually, the correct decision is to keep it while those conditions pertain.   Maybe after x years, the property will be worth €200k and the mortgage will be €50k, and then he needs to revisit the decision. 

Brendan


----------



## Sarenco (3 Feb 2015)

Brendan Burgess said:


> BoSI gave cheap trackers on an interest only full term basis.  Madness, maybe. But they did it.
> 
> But the same principle applies to repayment mortgages also. If the OP has a property worth €100k and a mortgage of €100k, or thereabouts, then usually, the correct decision is to keep it while those conditions pertain.   Maybe after x years, the property will be worth €200k and the mortgage will be €50k, and then he needs to revisit the decision.
> 
> Brendan



Ok, but presumably even with interest only BoSI mortgages the loan was repayable at end of the term - I assume they weren't perpetual? 

Turning to your example, the property may well be worth €200k after X years.  Or it could be worth €50k. Who knows?

If the principal outstanding on a €100k loan after the same X years is now €50k that means the mortgagor has paid down €50k on the loan.  That's a capital investment - not a profit.


----------



## Brendan Burgess (4 Feb 2015)

Brendan Burgess said:


> Maybe after x years, the property will be worth €200k and the mortgage will be €50k, and then he needs to revisit the decision.





Sarenco said:


> If the principal outstanding on a €100k loan after the same X years is now €50k that means the mortgagor has paid down €50k on the loan. That's a capital investment - not a profit.



Hi Sarenco,

Again you are inferring things from me which I have neither explicitly said nor implied. 

While he has a tracker mortgage roughly equal to the value of the property, the correct decision will usually be to keep it.  When these circumstances change, then he should revisit the decision.  The property price may rise. The property price may fall. The rate of interest may rise or fall. The rent may rise or fall. He may actually reach the end of the term and have to repay the capital. 

But he should make the decision today, based on the circumstances pertaining today. 

Brendan


----------



## Sarenco (4 Feb 2015)

Ah Brendan - I haven't inferred anything from your post.

You said "maybe after x years the property will be worth €200k".  I agreed with you - yes, the property may well be worth €200k after x years.  Where's the inference?

We are in violent agreement that a decision to acquire (or retain) any investment can only be made on the basis of the facts that are known at the time that the decision is made.  Nobody can accurately predict the future value of any asset and attempting to do so is a futile exercise.  Again, I think we are in agreement on this point but you might confirm.

So the next logical step is to determine what criteria should be applied in making the decision.  One approach is to determine whether or not the investor can continue to fund the investment and then simply hope for the best.  That doesn't seem like a very rigorous approach to me.  Do you disagree?

In my opinion calculating the net yield that any property can return is key to making a decision whether or not to acquire or retain that property for investment purposes.  Other criteria are certainly relevant but, in my opinion, are very much secondary to the yield calculation.

You seem to disagree with this approach but I am unclear what criteria you would apply in the decision making process.  When you say "the correct decision will usually be" are you referring to historic returns (in other words, how thing have generally turned out in the past) or something else?

If an investor has €50k of equity tied up in a property that is yielding x, then the question is surely whether to continue with that investment or to assess whether the €50k capital would be better applied elsewhere.  In other words, would an alternative investment have a higher expected return on a risk-adjusted basis?

I am genuinely not trying to trying to be argumentative for the sake of it - I simply don't understand what criteria you would apply at the time that the decision is made to retain the rental property.


----------



## Brendan Burgess (4 Feb 2015)

I set out  a full systematic approach to the question and all the factors which should be considered  in this post: 
Should I sell my home in negative equity or rent it out?




Sarenco said:


> Turning to your example, the property may well be worth €200k after X years. Or it could be worth €50k. Who knows?
> 
> If the principal outstanding on a €100k loan after the same X years is now €50k that means the mortgagor has paid down €50k on the loan. That's a capital investment - not a profit.



I linked your quoting my example, with the "that's a capital investment - not a profit" to be inferring that I implied that it was a profit.  Maybe that is not what you were inferring. Although I don't really know why you are stating the obvious in a post addressed to me. 

Brendan


----------



## Sarenco (4 Feb 2015)

Brendan Burgess said:


> I set out  a full systematic approach to the question and all the factors which should be considered  in this post:
> Should I sell my home in negative equity or rent it out?
> 
> 
> ...


 
Brendan

I took your use of the word "again" at the start of your post as a cross-reference to a previous thread where you suggested that I was implying that you were breaching the "no speculation rule".  For the record, I wasn't making any such implication then and I am making no such implication now.

I agree that it is stating the obvious to say that making principal payments on a loan is a capital investment and not a profit.  I wasn't inferring that you were saying otherwise.  I was simply dealing with the second element of your example for the sake of clarity.

I have no difficulty with anything that is contained in your key post. 

My difficulty is your key post does not contain any useful formula for analysing whether the retention of a rental property makes sense versus applying an investor's capital elsewhere.  Calculating the net rental profit for a particular property does not produce a useful number for comparative purposes.  In fact, a rental property could give rise to a net rental loss in any particular year (e.g. because of unusually high maintenance expenses in that year) but an investor could still logically decide to retain the property is he was satisfied that the net yield figure was sufficiently high when contrasted with other investment opportunities.

I am of the view that net yield before financing costs and tax (sometimes called the capitalisation rate) is the most useful formula for comparative purposes.  Others prefer to use return on investment. 

For the avoidance of doubt, I am not suggesting that net yield should be the sole consideration.  It is, however, a useful starting point.


----------



## tvman (4 Feb 2015)

here's my take

A decision to retain a leveraged property investment has two aspects which are worth analysing separately. 
 - Is the property worth retaining.
 - Is the loan worth retaining. 


The first (is the property worth retaining) should be decided based on the Net Present Value of the property, which will incorporate analysis of the expected rent, expenses, growth rate in rent, market value of the property (i.e. the opportunity cost of not selling it) and the investors required rate of return. 

The second - Is the loan worth retaining - can be answered by valuing the loan based on market rates of return and comparing this to the outstanding amount.

Example (highly simplified): 

Tracker mortgage at 1.5%
Interest Only (interest payable annually)
20 years
Principal €100K

To value the loan we need to know what rate the owner could borrow for this investment today. Lets say 4.25% (AIB standard variable)

From the perspective of the bank - the loan is annual 20 payments of €1,500 plus a payment of €100,000 in 20 years. The bank would lend today at 4.25%.

The present value of this loan is (i.e. the value of the payments the borrower has to make to repay this loan, expressed in today's terms)

1500/(1.0425) + 1500/ (1.0425)^2 + 1500/ (1.0425)^3.........101,500/(1.0425)^20

the present value of the loan repayments is €63,440. The borrower had the use of €100,000 for which they are paying €63,440 - Even if the property os overvalued by 30% - the optimal decision may still be to retain the property because of the subsidy from the lender.


----------



## Sarenco (4 Feb 2015)

tvman said:


> here's my take
> 
> A decision to retain a leveraged property investment has two aspects which are worth analysing separately.
> - Is the property worth retaining.
> ...


 
Good post.

I absolutely agree that the analysis as to whether a rental property should be retained is separate (albeit linked) to the analysis as to whether a loan relating to that property should be retained.

An NPV calculation is certainly another method for assessing a rental property but I personally prefer old fashioned yield calculations as my starting point.


----------



## Brendan Burgess (4 Feb 2015)

Sarenco said:


> My difficulty is your key post does not contain any useful formula for analysing whether the retention of a rental property makes sense versus applying an investor's capital elsewhere. Calculating the net rental profit for a particular property does not produce a useful number for comparative purposes. In fact, a rental property could give rise to a net rental loss in any particular year (e.g. because of unusually high maintenance expenses in that year) but an investor could still logically decide to retain the property is he was satisfied that the net yield figure was sufficiently high when contrasted with other investment opportunities.



Interesting point. Could you make it in response to the Key Post?


----------



## Brendan Burgess (4 Feb 2015)

Sarenco said:


> I absolutely agree that the analysis as to whether a rental property should be retained is separate (albeit linked) to the analysis as to whether a loan relating to that property should be retained.



I have to disagree with this. 

A property worth €100k yielding 6% funded by a mortgage of €100k costing 8%, does not look like a good investment to me. 
If the mortgage is 1% it's a great investment, at the moment.  When the inputs change, the decision should be reviewed. 

But I cannot see how you can treat them as separate. You can look at them separately, but then you have to combine them. 

Brendan


----------



## Sarenco (4 Feb 2015)

Brendan Burgess said:


> I have to disagree with this.
> 
> You can look at them separately, but then you have to combine them.
> 
> Brendan


 
That's really all I'm saying Brendan.

A property yielding 6% is not a great investment if an identical property is yielding 12%.

A mortgage rate of 1% is not cheap if the property can be re-mortgaged on identical terms at a rate of 0.1%.

The analysis of the rental property is separate, albeit linked, to the analysis of the loan.

I was at pains to point out that a net yield analysis is simply a starting point in assessing a rental property.  Financing terms, tax treatment, etc. at the time of the decision are all relevant.

I'll leave it there.


----------



## Brendan Burgess (4 Feb 2015)

Sarenco said:


> A property yielding 6% is not a great investment if an identical property is yielding 12%.
> 
> A mortgage rate of 1% is not cheap if the property can be re-mortgaged on identical terms at a rate of 0.1%.



This seems a completely pointless argument? The 1% tracker is embedded with the property.  There are no mortgages available at 0.1%. I would be surprised if there were yields of 12% available.  

We are trying to help the OP answer a question, and I can't see how such hypothetical reasoning helps in any way.


----------



## Sarenco (4 Feb 2015)

Brendan Burgess said:


> This seems a completely pointless argument? The 1% tracker is embedded with the property.  There are no mortgages available at 0.1%. I would be surprised if there were yields of 12% available.
> 
> We are trying to help the OP answer a question, and I can't see how such hypothetical reasoning helps in any way.


 
The hypothetical numbers were quite obviously not intended to reflect current market conditions - they were intended to demonstrate a point.

The OP asked how to figure out if the rental income on a property represented a good yield.  That was the question asked and I gave my opinion as to what I considered represented a good yield in the current market.

You responded by saying that asking what the yield is on a property was the wrong question to ask. 

I simply asked how you would assess a rental property if you ignored yield and you referenced your key post which does not set out any alternative formula for assessing the return on a property.  It does describe how you calculate net rental profit but determining whether or not a profit has been generated on an asset does not tell you whether that asset represents a better investment than any other investment.

I have repeatedly made the point that the cost of financing is a relevant factor and is a linked issue.  However, a mortgage can obviously be repaid without necessarily disposing of the property to which it relates - a mortgage is not embedded with a property.


----------



## Brendan Burgess (5 Feb 2015)

Sarenco said:


> However, a mortgage can obviously be repaid without necessarily disposing of the property to which it relates - a mortgage is not embedded with a property.



Yes, but the property cannot be disposed of without repaying the mortgage! 

Which is why you cannot look at property yield in isolation. 

Brendan


----------



## tvman (5 Feb 2015)

Sarenco said:


> Good post.
> 
> I absolutely agree that the analysis as to whether a rental property should be retained is separate (albeit linked) to the analysis as to whether a loan relating to that property should be retained.
> 
> An NPV calculation is certainly another method for assessing a rental property but I personally prefer old fashioned yield calculations as my starting point.



As long as you are comparing the yield to an opportunity cost of capital (i.e. the return on assets of equivalent risk) as you are suggesting - the approaches are basically the same.


----------



## Sarenco (5 Feb 2015)

tvman said:


> As long as you are comparing the yield to an opportunity cost of capital (i.e. the return on assets of equivalent risk) as you are suggesting - the approaches are basically the same.


 
Agreed.  I think it is important to use some metric to assess the risk-adjusted return on assets - there are certainly different methodologies that can be used for this purpose.


----------



## Sarenco (5 Feb 2015)

Brendan Burgess said:


> Yes, but the property cannot be disposed of without repaying the mortgage!
> 
> Which is why you cannot look at property yield in isolation.
> 
> Brendan


 
I never suggested that yield should be looked at in isolation.  I repeatedly made the point that other factors are also relevant - particularly the cost of finance.


----------



## dub_nerd (6 Feb 2015)

tvman said:


> To value the loan we need to know what rate the owner could borrow for this investment today. Lets say 4.25% (AIB standard variable)
> 
> From the perspective of the bank - the loan is annual 20 payments of €1,500 plus a payment of €100,000 in 20 years. The bank would lend today at 4.25%.
> 
> ...



Would like to understand this better. Is the relevant discount rate not the rate of inflation rather than the bank's current lending rate. After all the question under consideration was whether it was worth retaining the loan, i.e. having it versus not having it ... not versus having a more expensive loan.


----------



## 44brendan (6 Feb 2015)

The most interesting point relating to this extensive discussion is that one side pre-assumes that the investor with the tracker mortgage will have any alternative to either retaining the property and the associated RI or selling the property and paying off the mortgage in full. I.e. There is absolutely no way to diversify the funds invested as they are tied in to the relevant property. You cannot compare yields when the alternative is no return!!


----------



## Sarenco (6 Feb 2015)

44brendan said:


> The most interesting point relating to this extensive discussion is that one side pre-assumes that the investor with the tracker mortgage will have any alternative to either retaining the property and the associated RI or selling the property and paying off the mortgage in full. I.e. There is absolutely no way to diversify the funds invested as they are tied in to the relevant property. You cannot compare yields when the alternative is no return!!




Sorry Brendan - I'm not following you - would you mind re-phrasing?


----------



## jobseekr1 (8 Feb 2015)

Hi folks, 
Apologies for the delay in replying.
I've been away for a few days, and thank you for your extensive replies.
-Sarenco.
The calculation you listed of €6,240 (€520 x 12) is actually now 650 x 12, or 7,800 per anum rental
income. Realistically I'd say 60k to 80k is the most I'd get for the property, it is in a provincial town.
-Brendan.
Reading your post I get the vibe that I should hold onto the tracker at all costs.
If I sold this property, how would I go about transferring it to a future loan? If at all.
I honestly don't ever see the property hitting 100k in value, let alone 200k, but the rental demand 
is strong locally, and the tenant is fine.
You also mention "If the mortgage is 1% it's a great investment, at the moment. When the inputs change, the decision should be reviewed".
In other words, I'd be mad to sell?
So, Sarenco and Brendan, based on my estimate of a 60-80k value, would I be better off selling, or not?


----------



## Sarenco (8 Feb 2015)

jobseekr1 said:


> Hi folks,
> Apologies for the delay in replying.
> I've been away for a few days, and thank you for your extensive replies.
> -Sarenco.
> ...




Thanks for coming back to us.

Your updated figures suggest a gross yield of at least 9 per cent per annum, taking the upper end of your valuation.  That's a super yield and conservatively should return a net yield (before financing costs and tax) of at least 6 per cent per annum on average, over the long term.

You would expect a rental property in a provincial town to have a higher yield than  a rental property in a high income, city centre location as it is a riskier investment, in the sense that it may be more difficult to find suitable replacement tenants.

Your tracker also feeds into this decision as you are currently borrowing at 1 per cent to buy an asset with a net yield of 6 per cent plus.  Your mortgage rate obviously may rise in the future but you would expect inflation to be higher than is currently the case in such circumstances.  Rising inflation is your friend as it reduces the real value of your outstanding mortgage and you could reasonably expect rents to increase broadly in line with inflation over the medium term.

There is no such thing as a risk-free investment.  However, assuming you are reasonably comfortable that:- (a) you have no short or medium-term need to realise any equity in the property for other purposes; (b) the hassle and time involved with being a landlord is something you can deal with; (c) rental demand in the town is not unduly linked to a particular employer; and (d) you have sufficient cash reserves to meet expenses as they arise, then I would recommend that you hold on to the rental property as an investment.

Diversifying your investments across the two other major income producing asset classes (equities and fixed income) is also important but, on the face of it, your rental property looks like a keeper!


----------



## jobseekr1 (8 Feb 2015)

Thanks so much Sarenco for sussing that out. Based on your figures, I'll forget about selling it and hold in for the long term.
It's a provincial town, but a fairly prosperous one at that, and rents have rocketed of late compared to three years back and interest rate reduction has helped me too. A, B, C and D are all ok for now, so I'll hold tight. Thanks again!


----------



## Sarenco (8 Feb 2015)

No problem.

One other issue that I should have mentioned is income tax.

You will obviously need to pay income tax on all net rental profit and, bearing in mind that 25 per cent of mortgage interest payments and all LPT payments are not deductible, the tax bite can be significant.  If you have another loan at an interest rate that is higher than your net rental yield less financing costs and income tax, then you would be better off financially paying down that loan (ignoring possible capital appreciation on your rental property).  Everybody has a different effective tax rate so if you do have other debts, you would really need to crunch the numbers yourself to arrive at a conclusive position.

Paying down high interest loans (including non-tracker mortgages in the current environment) is often the optimal financial decision when income tax is taken into account.


----------

