New PPR - Keep investment property or sell it?

[Gordon Gekko]

This seems to be a topic on which people have very different views.

Take the following example:

- PPR mortgage of €750k at 3.3% variable. 30 years remaining.
- Investment property mortgage at ECB + 0.5% (so 0.55%). 15 years remaining. Property is worth €280k. €220k outstanding. Rent is €15k a year. Market rent is circa €17k a year, but the tenant is solid and long term so there's no real desire to increase it.

The plan is to leave the investment property in situ for the 15 years, and then sell it with a view to clearing the PPR mortgage. After 15 years there will be circa €400k left on the PPR mortgage, and the view is that even with very modest appreciation, the investment property will be worth at least that.

Does this plan make sense?

The person's AVCs are maxed out.

Many thanks.

 

[Joe_90]

As the tracker is effectively free money and if the person has €40k to pay the PPR mortgage and enough left over to pay the expenses on the rental and the tax on the rental and cope with any interest rate rises on the PPR and future childcare costs ect then its a great plan.

If "if's and and's" were "pots and pans" and all that.

 

[Bronte]

That's a very expensive PPR. And 30 years is long. What happens if interest rates go up? Is there much equity? What age in 30 years. I'd be throwing lump sums at that if I were you.

(In relation to interest rates, what goes down down down, will inevitable go up, a lot of talk recently about the US moving ,and then maybe the UK and who knows about Europe) When you owe 750K a small move is a lot. If you're 50 years of age and owe 60K and they go up 2% it won't break the bank. (in general)

 

[Gerard123]

Seems to make sense to me alright. Assuming that the PPR is under control and affordable. There is always the option of selling if pressure comes on.

Lets assume that in 15 years it is worth 350-400k. You then have an option of selling and paying off your PPR at that time. May be a bit of tax to be paid if there is a gain. However, seems to me that you're potentially on the path to owning your own PPR in 15 years if you stay the course and want to. Good situation to be in if you ask me. Wouldn't give that option up without a lot of thought. The tracker is too attractive to make a snap decision to sell, if your PPR is under control and lifestyle ok. Its the tracker cost that really makes this a viable solution I think. What I would advise is that all extra monies, any lump sums, etc, go towards your higher cost PPR mortgage. Any overpayments go to the PPR not to the tracker, pay the minimum amount required to continue the tracker.

Were you to sell the inv prop today, ok you generate say 60k and pay it down off PPR, but then I can't see how you would then be in a position to own your PPR in 15 years on basis of info provided.

 

[Sarenco]

I think you could certainly make a case for retaining the rental property on those facts but it’s a fairly close call either way.

In these circumstances, it looks like a straight decision between realising the €60k equity in the rental property and applying it against the PPR mortgage or retaining the rental. I am assuming that the borrower will retain a sufficient cash buffer (6 months’ rent is the rule of thumb) to address unexpected expenses, voids, etc.

Applying the realised equity against the PPR mortgage would generate a return equivalent to the interest rate charged over the life of the PPR mortgage – currently 3.3% - with zero taxes or investment costs. So that’s the target return the rental property has to at least match.

The rental property is capable of generating a net yield of around 4.25% (€17k/€280k x 70%) and is being financed at a rate of 0.55%. So on a net basis that’s around 3.7% which is obviously higher than the PPR mortgage rate. Happy days – retaining the rental wins!

Income tax will obviously eat a very significant portion of the net income generated by the rental but, on the other hand, a considerable element of the return is being generated out of OPM (other people’s money - borrowings). It is also probably reasonable to assume that the capital value of the rental will rise - and the real value of the outstanding mortgage balance will fall - in line with inflation over the proposed holding period.

So, on balance, I think you could justify retaining the rental on the basis of its projected return.

The other side of the equation is obviously whether the projected return justifies the risk inherent in retaining the rental.

A €750k mortgage on a PPR is definitely in jumbo territory and combined with the mortgage on the rental you’re looking at total mortgage debt of €970k. As Bronte correctly points out, that’s a very significant exposure to interest rate increases. Whether or not a borrower could reasonably absorb any such increases really turns on their individual circumstances.

It might be reasonable, or at least tenable, for borrowers their 30s to carry total debt equivalent to around three times their gross household income (including rental income) but I don’t think that would be a reasonable debt burden for borrowers in their 40s or 50s.

 

[Gordon Gekko]

Thanks for the very detailed responses.

There's a decent amount of equity in both properties (around 25%) and whilst I agree with your view on debt Sarenco, debt funded at 50bps over ECB lends itself to softer analysis. The whole lot is at 2.68% which is pretty attractive all things considered.

If anything, I believe that variable rates will go down rather than up (due to competetion). I'm also of the view that interest rates will stay low for a generation and lag inflation for longer than that.

 

[Brendan Burgess]

This is a very interesting question. And this is how I would approach it.

You do not need to forecast interest rates for the next generation or make a plan for what you will do in 30 years because you are not stuck with the decision you make today for the next 30 years. Work out what is right under the current circumstances and review the decision if the underlying factors change.

First look at the investment.

You can adjust these figures for the expenses or anything else which reduce your net profit.


If you sell the property you will have €60,000 to pay off your PPR

This will save you €60,000 @3.3% or €2,000 a year.

So assuming property prices remain the same, the decision is not even close. You are better off by €5,000 a year at the moment.

Other factors to consider

The outlook for house prices and your exposure to property
You already have a property worth €1m so maybe owning another property worth €280k is excessively risky.
That would depend on your income, age, etc. I am not sure that reducing your assets from €1,280k to €1,000 will make that much of a difference.

Your heavy debt and exposure to interest rates
Again, you are obviously comfortable with the €750k mortgage on your home at present. Presumably you have a high reliable income which can service these repayments easily? Knocking €60k off the mortgage won't make that much difference.

I would expect that you would be able to refinance your home loan at below 3% within the next 6 months. However, in the medium term, I would expect rates to rise. I could be wrong on both counts.

I am not concerned at you having a mortgage of €220k @0.55%. It's well covered by the rent and you have reliable tenants.

Review the decision after a year and every year using the above system

Over time, as you pay down the capital on the tracker and if the property rises in value and if interest rates rise, the numbers will change so that selling and paying down the PPR will make sense.

Brendan

 

[Gordon Gekko]

Thank you Brendan

 

[Sarenco]

Hi Brendan

As noted above, I agree that the projected return on the rental property "beats" the return on paying down the PPR mortgage in these circumstances. However, I don't think the extent of the difference in return is as significant as your figures suggest.

I would project the after-tax return on the rental property to be in the region of €4,000 (assuming a 52% marginal rate rate) versus a return of around €2,000 by paying down the PPR.

Whether the risk of retaining the rental property is adequately compensated by a difference in return of around €2,000 per annum is a matter of judgment. The current tenants may well be reliable but that might not be the case if they lose their jobs.

Also, an unanticipated spike in interest rates can never be ruled out. If we do have a significant increase in interest rates, that is likely to have a correspondingly negative impact on house prices (as happened in the UK in the early 90s). Selling a rental property in such circumstances would permanently lock-in a fall in value.

Two other minor considerations:

• A reduced PPR mortgage will require a lower amount of life assurance; and
• Presumably some of the furniture, etc. in the rental property could be used in the PPR.

I agree that, on balance, retaining the rental property is probably justified in this case but I think it's a much closer call than your figures would imply.