Key Post Keep property as Rental or Sell?

[Sarenco]

Updated May 2020

The question regularly comes up on AAM whether somebody should keep an apartment that their family has outgrown as a rental or whether they should just sell up.

Borrowers often run projections on the anticipated rental income from an apartment with a cheap tracker and conclude that it's worth retaining, without running the rule on the potentially higher interest payments on their new family home mortgage.

One key question to ask is whether the projected rental income from the apartment, after all expenses and taxes, will exceed the projected interest savings by cashing out any equity in the apartment and using it to pay part of the purchase price for the new home.

Other considerations (risks, hassle, cash flow, CGT, potential capital appreciation or depreciation) are noted in the comments below.

While no two circumstances will ever be identical, a typical scenario might look something like this:-




The following are examples of what the projections might look like on the basis of that fact pattern:-

Option 1 – Keep Apartment as Rental






Option 2 – Cash out Home Equity

 

[Sarenco]

Original post was not in table format.

 

[Brendan Burgess]

Other considerations

Risk and reward of owning more property

If you keep the apartment you will benefit from any increases in property prices. Any increase in value up to the original purchase price of €250k will be free of Capital Gains Tax.

However, if house prices fall and remain down, then you will lose money.

Hassle and worry of owning a rental property

Owning a rental property is more like a business than a passive investment such as having a deposit account or an investment fund. Even if you pass over the management to a letting agent, you will still have administration and tax returns to do. These are easily manageable when things go well, but become very time consuming if you get a bad tenant.

Cash-flow


While the most important consideration is the profitability of the investment by comparing the rent received to the interest paid, it's also important to make sure that you can comfortably afford the additional cash payments each month.

In effect, the extra €650 of cash payments is due to the fact that you are repaying the capital on the mortgage. This is not an expense, but a form of savings. But it could become a real problem for you if the tenant stopped paying.

 

[Sarenco]

Thanks for the feedback Brendan - much appreciated.

1) My thinking was to show the figure that retaining the rental had to "beat" first but you may well be right that it would be easier to digest if I reversed the order and included some additional text as suggested.

2) The tracker rate in my example was ECB+0.5%. So it's 80% of €150k @0.5% = €600.

Incidentally, if you run the figures with a tracker rate of ECB+1% (rather than 0.5%) - but keep everything else constant - cashing out the home equity and porting the tracker still comes out ahead of retaining the apartment as a rental but it's much closer (€3,200 versus €3,190).

I think it's better to run the figures on the basis of the tax code as it stands today. I know the Minister indicated in his last budget speech that he intends to incrementally increase the deductibility by 5% per year (so that there will be full interest deductibility by 2021) but who knows whether his successor will follow through on this commitment.

In any event, the mortgage will obviously get paid down over time so the proportion of deductible interest will fall over time.

3) I think most people that retain a former PPR as a rental do in fact continue to pay the mortgage protection premiums. It's incredibly cheap life assurance (bear in mind the family profile in my example) and the premiums are deductible for tax purposes.

On the other side of the equation, I considered providing for the increased level of life cover that would be required by taking out a larger mortgage on the new family home. However, the amount involved would probably be relatively trivial and I don't want to complicate things unnecessarily.

4) Yes, I deliberately assumed zero voids or over-holding periods in my projection. I actually don't think that's very realistic over the medium/long-term but I didn't want to be accused of being overly pessimistic. I think your suggestion of making this assumption clear is a good one.

5) That's actually the very point that I was trying to reflect in the note.

If the furniture/contents are left in the rental, then their value can gradually be claimed back as capital allowances over time. However, the furniture/contents will obviously not be available for use in the new family home so will have to be replaced (and the cost will not be deductible for tax purposes). I thought the best thing to do in the projection was simply to call it a wash.

My Repairs & Maintenance figure of €450 is intended to cover the cost of replacing furniture, white goods, painting and general up keep. I think an annual figure of €1,000 might be a bit on the high side for an apartment but perhaps €450 is too low. Would €600 be a happy medium?

 

[Brendan Burgess]

It might be useful to compile a list of factors which should be taken into consideration.

The rental property market in your area
If it's difficult to rent an apartment in your area, then you are probably better off selling it and moving your tracker.

The less equity you have, the less attractive porting it becomes

On the one hand, if your tracker mortgage is €200k and the apartment is worth €200k, then you are not releasing any equity to reduce the value of the new mortgage.

On the other hand, if you have a mortgage of €50k on a property worth €300k, it argues for selling the apartment.

The higher the deposit you have in cash, the less attractive porting the tracker becomes
If you have no deposit, you will have to sell your apartment. If you have only a 20% deposit, you will be paying the rates appropriate to an 80% mortgage and selling the apartment would get you a lower LTV and so a lower mortgage rate.

If you already have 50% of the cost of the house as a deposit, the additional equity won't help you get a lower rate.


You need to factor in the mortgage rate charged on the new mortgage and the generosity of the deal

AIB is the best combination in that they have low rates on the new mortgage and their deal lasts for the remaining length of the tracker.
BoI is the least attractive as their tracker mover deal lasts only 5 years and they have high variable rates on the balance of the mortgage, but you could fix.
Ulster Bank has low rates, but the deal lasts only 10 years - but that should be enough for most people
ptsb has high mortgage rates for existing customers but their deal lasts the full remaining term of the tracker.

If your resulting LTV would be too high if you keep the apartment, you should lean towards selling it.

 

[Baby boomer]

Top post updated and somewhat simplified.

All comments welcome.

Excellent summary, thanks for that.

A couple of things strike me:

1. €1500 rent pm seems a bit on the low side for a property worth €300k. I'd say at least 1800 and closer to €2000pm for Dublin apartments.

2. Over time, the rent should normally increase - although this isn't a given with the current shortage of housing distorting the market upwards.

3. Over time, the interest saving will decrease as the capital is gradually paid down.

4. By keeping the apartment, you have a geared investment in the Dublin property market. Historically, this has been a good position and you could normally expect capital growth as well.

So, my instinct is to hold the apartment. On the other hand, there is exposure to risk of property price crash (geared ) and you have a very non-diversified investment basket. It all depends on your attitude to risk.

 

[Brendan Burgess]

Hi Sarenco

I have put your first post in table format to make it easier to read.
I have put the list of expenses into a second post so as not to distract from the main points.
I have kept the original post as the third post for reference. If you are happy with my summary, I will delete the original.


I would stress the following:

1) This is a template using a particular set of circumstances
You must plug your own figures into this template.
For example, your interest rate may be higher or lower.
Your rent may be higher or lower
You may not use an estate agent to manage it for you
You may not be on the top tax rate.

2) This is the decision based on today's figures.
If you decide to retain the apartment, you should review the figures every couple of years.
For example, as you pay off the capital on the investment property - the value of a cheap tracker becomes lower.

3) I think it's worth linking to this thread in the first post

Key Post - CGT implications of keeping your PPR as an investment after trading up

This has come up in a few threads, and I think it would be worth teasing out separately. The CGT rules If you sell your PPR within 12 months of vacating it, there is no CGT. If you keep it as an investment, the CGT If your house is worth less than you paid for it, when it ceases to be your...

www.askaboutmoney.com

 

[Brendan Burgess]

On reflection, this additional stuff is not relevant to the decision.

 

[Sarenco]

Thanks Brendan - that looks much neater.

On reflection, this additional stuff is not relevant to the decision.

You're probably right.

My reasoning for including that information was to demonstrate that this hypothetical couple have a genuine choice (i.e. they have sufficient cash savings to acquire the new house without selling the apartment, have a diversified portfolio of retirement savings, etc.). The reference to their ages and the fact that they have kids could feed into the cash flow piece (which probably needs to be updated to reflect the updated fact pattern).

 

[Brendan Burgess]

My reasoning for including that information was to demonstrate that this hypothetical couple have a genuine choice

Fair enough.

Brendan

 

[cremeegg]

Good summary Sarenco, a few thoughts.

Agent fees, if a person is going to rent out a property as an investment and they are considering using a letting agent they should think again, thats the wrong mindset for a landlord.

Annual service charges. Properties with service charges make worse investments. The capitalised value of a €1,750 p.a. service charge at 4% is €43,750 and 4% is generous. 1% is more like it and that gives €175,000

If I were in the situation outlined above I would keep the apartment, I would not have a letting agent, that saves €2,100 p.a. and I would hope for though not count on capital appreciation, both real and perhaps more importantly if inflation roars back, nominal.

The one area of concern would be cashflow. I would need to be certain that I would never become a forced seller. That brings in questions around security of income which are not considered here.

 

[Sarenco]

Properties with service charges make worse investments

Well, all modern apartments will have an OMC service charge.

Obviously stand-alone properties will have other costs (house insurance, exterior maintenance, gardening, waste disposal, etc.).

I would not have a letting agent, that saves €2,100 p.a.

Bear in mind that an agent's fees are deductible for tax purposes so in reality you would only be saving €1k. Is €1k sufficient compensation for the time and hassle involved with managing a rental property?

 

[presidenttttt]

Updated May 2020
....

While no two circumstances will ever be identical, a typical scenario might look something like this:-

Market Value of Property - €300,000
Original Purchase Price - €250,000
Mortgage Outstanding – €100,000
Remaining Term – 10 years
Tracker Rate – ECB+1%

Projected Rent – €1,750 per month
Value of Target House - €400,000
Projected Initial Mortgage Rate on New PPR - 3%
Cost of Moving (stamp duty, legal, additional furniture, etc.)
less the value of any "cash back offer" - €10,000


Option 1 – Keep Apartment as Rental

Gross rental income............................................................................ 21,000
....
LPT.........................................................................................................................315

Net Rental Income After Tax...............................................................6,405


Option 2 – Cash out Home Equity

Interest saved by liquidating equity
in apartment and applying to
house purchase (€200k @ 3%)................................................................ 6,000

Mortgage protection premiums on additional
borrowings (€200k)............................................................................................450

Net Total Saving..................,....................................................................... 6,450

I am trying to understand how to interpret the numbers and their impact. Going forward presumably these numbers diverge on an annual basis, with interest costs reducing and rent increasing - so in this example where the two numbers are almost the same, we can expect little gain from retaining property initially but a long-term plan looks healthy?

 

[Sarenco]

The framework allows for a "point in time" analysis of where is the best place to deploy your capital, based on all known facts at the time of the analysis.

Once you project into the future you have to make all sorts of assumptions, which may or may not turn out to be reasonable.

Also, bear in mind that as you pay down a mortgage you will have more capital invested in a property. So, all being equal, the return on your invested capital will reduce.

 

[NoRegretsCoyote]

and rent increasing

Why would you assume this? Rents are historically kind of volatile in Ireland.

2012-date has been a golden period for landlords: ultra low rates, rising rents, and rising capital values. but I wouldn't build a business plan on it continuing like this.