Is now a good time to invest in residential property?

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DerKaiser

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I've split out a case study I developed on another thread.

In this specific thread I want to set out a framework for evaluating the financial decision of whether to purchase an investment property.

In this analysis the key factor, in terms of personal situation, is whether you need to borrow to purchase or if you have sufficient savings.

Let's assume the following realistic scenario:
A house costs €250k
Rent is €12k p.a.
Deposit Savings rate net of dirt is 2%
Mortgage interest on buy to let is 5.5%
Individual's marginal tax rate is the higher level (52%)

For simplicity I'll initially ignore a couple of factors which probably should be taken into account in more detailed decision making e.g. costs of owning (repairs, etc), rent inflation, etc.

We'll also assume that this is a buy to hold decision rather than a short term speculative play.

1. Property investment versus savings
The key factor is how net of tax rents compare to net of tax interest on savings

In this case buying property is a marginal winner as €5.76k* collected net of tax rent exceeds €5k in savings interest forgone.

2. Is it worth borrowing for property investment
The key factor is how net of tax rents compare to cost of borrowing

In this case buying property is a clear loser as €11.1k** collected net of tax rent falls short of €13.75k in interest repayments.

*€12k rent after 52% tax
**€12k rent after 52% tax, allowing for 75% interest offset

Developing the scenario
If we build in a couple of more realistic assumptions e.g. rents increase @1.5% p.a. and owner has €2500 p.a. in costs, we get the following:

Scenario 1: Buying reduces net income initially but provides a greater income in the long run (decision is to buy)
Scenario 2: Rent falls well short of interest repayments and will take over 25 years to exceed them (decision is don't buy)

Obviously there are many other factors / risks to consider, but this method provides an initial framework to make a decision.

As can be seen, it is very dependent on whether you are a borrower or saver and it is also hugely sensitive to deposit savings rates, mortgage interest rates, taxes on savings, taxes on rents, marginal tax rates and long term expected growth in rents.

All this before even getting into the drag of being a landlord!

Simple Mathematical rule of thumb
In each circumstance we are effectively targetting a ratio of rent to market value that is the tipping point for the decision to buy.

In the scenario I have chosen the ratio of rent to market value is 4.8% (€12k/€250k). Allowing for ownership expenses of €2.5k, the effective rate is 3.8% (€9.5k/€250k). This drops to 1.8% if the marginal tax rate is 52% and you have no mortgage. For the scenario we have considered, it stays close to the 3.8% level if you do have a mortgage (i.e no tax is due).

A return of 2% is available on savings, whilst a mortgage costs 5.5%. If there is expected rent inflation, you can simply deduct the level of inflation from the interest rates to arrive at an effective "real" interest rate. In this case 0.5% on savings and 4% on the mortgage.

The simple rule of thumb then becomes 'purchase if the effective rental yield exceeds the real interest rate'.

For the person with savings the 1.8% rental yield net of tax comfortably beats the 'real interest rate net of tax' of 0.5%.

For the borrower the 3.8% rental yield falls short of the 'real interest rate net of tax' of 4%.
 
Sorry Bronte, not going to get into examples beyond the one I've posted unless they highlight anything significant that I've forgotten. In any case, I've only considered the fundamnetals of buying to hold for the very long term in my examples, wouldn't pretend to have any insight into short to medium term fluctuations.
 
Hi Bronte

An interesting question, but I think that it takes this thread a bit off topic. Der Kaiser is dealing with the specific issue of someone who is thinking of investing in a property to make a profit.

It seems that you are buying a holiday home which will have some income?

A balanced post on "the future direction of Irish house prices" would be a great complement to DerKaiser's work. Fancy the challenge?

Even if you just kick it off with your own thoughts, you will spark responses which you can factor into your OP.

Brendan
 
A key factor to consider here is your overall portfolio.

Borrowing to buy property increases the risk.
If you already have borrowings, you are making it even more riskier.

If you have the savings to buy a property, but you have a mortgage on your own home, then you are probably better off paying off your home loan, especially if it is on an expensive SVR.

Most people who are considering investing in property already own their own home. As such they have an exposure to the rises and falls in the property market. They are probably better off diversifying by buying shares.

You should also compare investing in property to investing in shares.
For me, the flexibility of shares is a huge advantage. But I can handle their extreme volatility.

For me, I could not bear to be a landlord. But many people don't have that problem.
 
I'd argue that your primary residence should not be seen as part of your investment portfolio. You have simply agreed a price for one of your most basic needs.

Beyond that I'd wholeheartedly agree about concentration risk. Long term scenario analysis has always proven the benefits of appropriate diversification as a means of surviving short term specific shocks.
 
Brendan Burgess said:
A balanced post on "the future direction of Irish house prices" would be a great complement to DerKaiser's work. Fancy the challenge?

Even if you just kick it off with your own thoughts, you will spark responses which you can factor into your OP.
Click to expand...

But wouldn't I be speculating on house prices next year, naturally I already am thinking about it but am I allowed to talk about that?
 
Hi Bronte

Just to be clear. We don't allow speculation about house prices on Askaboutmoney.

But if you or anyone else wants to write a balanced piece on it summarising all the factors in favour of an increase and all the factors in favour of a decrease, it would be acceptable. We will allow people to respond to that post so that you can update the Key Post.

That would be the ideal outcome. But people seem to have great difficulty writing a balanced piece. So we might settle for a well written piece arguing one side or the other and then see if someone argues the other side.

I find it very odd that for 6 years people have complained about the ban, but nobody has actually sat down and written a piece on the issue.
 
Hi DerKaiser,

Something I've observed recently (not in any scientific way -just my own spotting) is that the rental yield rate tends to improve on properties as you go down the price scale. So while €12,000 as an annual rent on a €250,000 property might be realistic, it doesn't follow that €6,000 would be a realistic rent for a €125,000 property - the rent would probably be higher. Similarly, you're likely to get less than €24,000 rent for a €500,000 property.

I would therefore be inclined to conclude that you're better off buying properties at the lower end of the price range, all other things being equal.
 
Hi Liam

That is a very good point.

In general, investors get better yields from apartments than from 4 bedroom houses. There is probably a lot less hassle as well.

Brendan
 
LDFerguson said:
I would therefore be inclined to conclude that you're better off buying properties at the lower end of the price range, all other things being equal.
Click to expand...

Oldnick an experience landlord in Dublin has often pointed that out and he's right. There are not enough people earning enough salary to be able to rent for much more than 2k per month. And my own experience is that houses rent for less than apartments even though houses cost more and the better area house a lot more.
 
Brendan Burgess said:
I find it very odd that for 6 years people have complained about the ban, but nobody has actually sat down and written a piece on the issue.
Click to expand...

My only complaint about the ban is that if someone asks on here if it's a good idea right now to buy we cannot say anything about house prices.

Anyway I'll try this without speculating.

Next year we are finally going to begin the insolvency regime. This means that the properties the banks have been holding off on dealing with will start to move. And the only way they move is if the banks repossess, starting with buy to lets, so mostly I guess apartments, and this will flood the market. Logically if you flood a market, where there are few buyers, and even fewer mortgage applications going though you create a downward spiral.

In addition to the insolvency regime it is my understanding that the High court judgment about 2009 mortgages is going to be fixed. Currently it means banks are unable to reposses and sell. This too will have a detrimental effect on property prices.

I would assume that properties in good city locations will not be overtly affected. And particularly the family home market in Dublin.

In relation to apartments, it is I believe current bank policy to not lend on any apartment outside Dublin, Cork & Galway. What does that say about apartment values elsewhere. In any case most apartments in Irealnd were appallingly built, so no matter how cheap, people now know this and will avoid them at all costs. Why would you buy one of these in any case when there are family homes at reasonable prices.

Emigration has meant that a lot of people have left houses behind. Not sure of the demographies of this. But logically people have to move from remote areas to either a city or abroad. There is no one to move back into those areas, even with cheap house prices. In any case why would you buy a large house in say Virginia, Cavan if you're going to have to travel to work in Dublin. Better to buy something smaller closer to Dublin.
 
Bronte said:
Next year we are finally going to begin the insolvency regime. This means that the properties the banks have been holding off on dealing with will start to move. And the only way they move is if the banks repossess, starting with buy to lets, so mostly I guess apartments, and this will flood the market. Logically if you flood a market, where there are few buyers, and even fewer mortgage applications going though you create a downward spiral.
Click to expand...

I haven't been following this too closely. Is there a hard date for when the new insolvency regime comes in, or is it still at the "discussion" phase?

Are there any published figures (speculative or not) for how many properties are likely to come on the market as a result?
 
I agree with Bronte that the banks will commence repossession of BTLs next year on a serious scale, but I don't agree that this will result in a flooding of the market. The banks realise that flooding the market with property is definitely not the way to go.

The banks have been preparing for this for quite a while and they are already advertising for "Property Receivers" who will take the properties on, on behalf of the banks and manage them. In many cases rental yields are not bad at all and in these cases continuing to keep the properties rented is actually a valid option.

One of the main objectives of the banks is to get the properties away from owners who are collecting rents from tenants and still allowing their mortgage arrears to mount. Many owners realise that they are now in the end game and trying to salvage as much cash for themselves as possible before the curtain comes down.This type of case will be tackled first
 
There will be no flooding of the market. Even the central bank have said that repossessions of just the BTL sector are unlikely to increase to "normal levels" when compared with other countries. Banks have already been holding on to existing property or selling off-market in some cases. Repossessions are low enough as is that neither makes much difference.

To put it in perspective, even if repossessions triple, it'll still be way below that of the North of Ireland.

Until the argument changes away from the protecting the family home, we are unlikely to see a return of a normal market. The current situation has basically incentivised anyone who has a family house not to pay their mortgage, especially if they have a tracker.

The legal situation is such that if you have a house now and stop paying, they can not legally repossess. This is the loophole they have been told to fix, the Gov are just trying to insert "protections for the family home", which if they get their way will keep the status quo for family homes.

Regarding the personal insolvency stuff coming through, the banks have a full veto on it and you have likes of Ray MacSharry from PTSB [1] simply telling it as it will be, there will be no debt forgiveness from the banks. Basically if you are massively underwater on your house, they want to take every thing and then keep after you, exactly the same as the current system.

Realistically there are a whole lot of people out there who can't pay and need help, and as much as it pains me to say it, they need to get some sort of debt forgiveness. And before people think, I'm one of those with zero debt and I am working so I know that means increased taxes.

In relation to prices and their direction, the current position in completely arbitrary. Lots of markets have shown that over a long period of time, prices tend to correlate in relation to rents, and rents tend to correlate as a percentage of take-home after-tax pay. The only difference today is that Europe is effectively inflation capped due to Germany which should be pushing prices down in relation to historical normals. As strange as it may seem, but high interest rates actually help increase prices as high interest periods normally have high inflation. It has the effect of making repayments much more affordable much quicker.

[1] [broken link removed]
 
paulie83 said:
Most of the BTL mortgages that are now in arrears were taken out by speculators who didn't care or understand the term "rental yield".
Click to expand...

While I don't disagree in general, the Section 23 properties in the past changed the way yields needed to be calculated. I did here of a few other tax "incentives" that further threw the need for yield out the door too.
 
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