Should I sell an investment property to pay down home loan?

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dave2015

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Hi
In lucky position to have some equity back in a rental property. Trying to work out if should sell or hold. Ideal medium term view is to pay chunk off mortgage on current home but obviously there are market and economic risks to doing now versus 10 years time. i.e I save interest on other mortgage, I avoid having to fork out cash shortfall annually, risk of major work etc etc.
I'll throw down numbers, if anyone has a few mins and some advice would be welcome. Should say I can afford current mortgage and the shortfall so this is purely the numbers.

Current Equity-40k (after all fees deducted)
Equity in 10 years-100k (assuming zero increase in price)
If I factor in an annual cash shortfall (Rent In less Mortgage, repairs, painting, tax etc) of 4k and the interest I would have saved had I paid 40k off the 3.2% mortgage I'm down to only being 8k better off. (100k-40k(equity now)-40k(shortfall)-12k(interest saving))

Obviously I'm making a lot of assumptions here, even a 2% annual increase in prices makes the figures stack up a lot better, equity would be 50k more.
Is this the right way to look at it or should I purely look at a on investment yield? That's 5% (13k rent on 260k value).

Thanks
 
How much is the loan on your house? What rate?

How much is rental property worth?
How much is the loan on the rental property?

How much are repair bills etc?
How much is the tax bill?
 
1. 340k @3.2%
2. 260k
3. 210k
4. Allowing 2.5k p/a for everything
5. 5k p/a at current income
 
Forget about repayments and capital repayments and the 20 year horizon. You should judge all these on an annual basis. So the first step is to assess whether this is a profitable investment or not. Then is the profit worth the hassle and the risk.

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What is the rate of interest on the Buy to Let? I suspect it's a tracker, in which case the likely result would be to retain the investment property for now.

Brendan
 
Thanks Brendan, appreciate that. Yes a tracker on the buy to let. Numbers below so ~2k profit. Not sure that's worth it to me, thus far I've been lucky and have same tenants for last 6/7 years so no gaps in income. Wouldn't take much to tip it into negative territory be it a change in tenants or a large one off expense.

Rental Income 13,000.00

Interest (2,400.00)

Interest Forgone (1,280.00)

Costs (2,500.00)

Profit before tax 6,820.00

Tax (4,500.00)

Profit after tax 2,320.00
 
Couple of comments:-
  • Your provision for expenses looks a bit on the low side to me. Don't forget to factor in the cost of your own time (assuming you don't work for free!) and bear in mind that repair bills tend to increase as a property ages. In my experience, over the long-term, expenses together with over holding and void periods, tend to average at around 30% of a property's achievable annual rent.
  • Your rental property is currently cash-flow negative (when you take account of the principal payments on the mortgage). While you can afford to fund this shortfall from your other income, is it preventing you from maximising contributions to a (tax deferred) pension vehicle?
Overall, retaining the rental looks like a lot of risk and hassle to me for a pretty slim return.
 
Thanks Sarenco, you're probably right. Like I said been lucky thus far with consistent tenants. I could justifiably increase rent about 2k p/a but this will force them out and ill be into a less stable tenancy possibly so all things considered I've been trying to keep them in it. And yes my fear is the upkeep cranking up.
I contribute 10% so limit would be 20% in my age bracket, I could switch the contribution to that.
 
A profit after tax of €2,320 is probably too small for the work and risk involved.

It becomes less attractive as you pay capital off your tracker. (Your equity increases so the amount of home interest you could save increases)

I am a bit confused about the value of your property. Anyway, with a €340k loan, I think you should go for the certainty of overpaying that rather than increasing your contributions to your pension fund. If your home is in negative equity, I think you should certainly pay down the loan rather than contribute to a pension fund.

Brendan
 
Thanks Brendan

I can clear up any confusion if may change advice?

Home is not in negative equity, 70% LTV
 
OK, so you can probably handle the risk of falling house prices or a non paying tenant or a rise in interest rates.

But it's probably not worth the hassle.

Brendan
 
dave2015 said:
. Wouldn't take much to tip it into negative territory be it a change in tenants or a large one off expense.
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Which is precisely why you should be retaining your 2K annual profit in your rent account for the day it is needed.

Are you sure the tenants would leave if you increased the rent, another poster on here had that dilemma and went to the tenants and asked them to suggest a rent increase ! And it worked to mutually satisfaction of both parties.
 
Brendan Burgess said:
Forget about repayments and capital repayments and the 20 year horizon. You should judge all these on an annual basis.
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In the first instance, you should certainly judge these on an annual basis. In this case the result seems to be marginal, the OP makes a small profit, may not be worth the trouble.

However there is another aspect. The capital value of the property. While no one can know the future, that is no reason to ignore capital position. In reality different capital outcomes are likely to far outweigh total annual profits or losses.

Consider a situation where an investor has little or no equity in a property, and there is a small annual profit or loss, where the investor can afford the cash-flow aspect of repaying the mortgage.

The investor has a very valuable, free, one way bet on future capital appreciation. If prices rise during the mortgage period the investor can sell and take the capital profit, if prices fall, the investor need not sell. They can hold on and see if prices rise next year.

When the mortgage is cleared, whatever the sale price of the property is belongs to the investor.

This poster seems to me to be in this situation, except that prices have gone up a little and she has some equity.

Keep the property, if prices rise 5% next year you can sell and make €13K more than you would now. If prices fall, don't sell and you are no worse off than you are now.
 
cremeegg said:
The investor has a very valuable, free, one way bet on future capital appreciation.
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Is it really a free bet? The OP has ~€40k of capital tied up in the rental and it is currently cash flow negative to the tune of ~€4k p.a., which has to be funded from his other, after-tax, income.

What happens if the tenant losses his job and can't pay his rent and/or the boiler blows up? Whatever way you look at it, directly held rental properties are highly concentrated, risky investments.

Personally, if I was in the OP’s position I would sell the rental and apply the net proceeds against the balance of his PPR mortgage. The resulting improved cash flow position should then allow the OP to increase contributions to a tax-deferred pension account (where, at the OP’s age I would primarily invest in broadly diversified equity funds).
 
If property rises 5% next year the OP will make €260,000 by 5% = €13,000

If the OP follows your advice and invests €40,000 in a pension and that goes up by 5% the op will make €40,000 by 5% = €2,000.
 
cremeegg said:
If property rises 5% next year the OP will make €260,000 by 5% = €13,000

If the OP follows your advice and invests €40,000 in a pension and that goes up by 5% the op will make €40,000 by 5% = €2,000.
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Eh, I didn't actually advise the OP to invest €40k in a pension.

I said that personally, if I was in his position, I would sell the rental and apply the net proceeds (~€40k) against the balance of the mortgage on his PPR.

That would de-risk his financial position significantly. It would also improve his cash flow (he wouldn't have to fund the negative cash-flow on the rental from his taxed income) and that would put him in a position to increase contributions to his pension (which he currently is not maximising).

If the OP wants to continue to take a leveraged bet on short-term house price increases, well that's obviously his choice. However, I don't think it's accurate to describe that option as a "free, one way bet".
 
Calling it a "free, one way bet" is clearly stretching things, but we can't ignore the fact that it is a leveraged bet which is financed at an extraordinarily attractive rate. The OP has €260k "in the market" using only €40k of his/her own cash.

I'd also be keen to know the OP's base cost for the property. How much (if any) of any future upside is tax-free?
 
Leverage certainly increases an investor's exposure to a given market. As such, it magnifies potential gains and, equally, potential losses.

It is currently possible to gain leveraged exposure to equities, through CFDs, leveraged ETFs, etc., at historically low rates and yet you rarely hear people advocating this approach to investing in this asset class. Leveraged property plays seem to hold a particular fascination for some people that always struck me as odd.
 
Sarenco said:
Leverage certainly increases an investor's exposure to a given market. As such, it magnifies potential gains and, equally, potential losses.

It is currently possible to gain leveraged exposure to equities, through CFDs, leveraged ETFs, etc., at historically low rates and yet you rarely hear people advocating this approach to investing in this asset class. Leveraged property plays seem to hold a particular fascination for some people that always struck me as odd.
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Where would you get such leverage at tracker rates (and tax deductible interest)?

Non-deductible funding at 3% is a lot different to deductible funding at (say) 0.5% (which I have).
 
Gordon Gekko said:
Non-deductible funding at 3% is a lot different to deductible funding at (say) 0.5% (which I have).
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Sorry Gordon, I didn't realise you were referencing your own situation.

There is no doubt that a, largely tax deductible, current borrowing rate of 0.5% is exceptionally low by any standards, historical or otherwise. That rate could rise of course but, as things stand, it's very cheap money. No doubt about it.

But it's still leverage - it still magnifies all capital gains and losses on the underlying asset. Even if the cost of credit was zero, you are still taking a leveraged bet on the future value of that asset. Whether the value of the underlying asset rises or falls, you still have to meet your loan repayment obligations and you still have to meet all other holding costs relating to that asset.

My point is simply that a leveraged bet on the future value of any asset always carries a higher risk than an unleveraged bet on that asset - regardless of the cost of credit.

I'm not suggesting that this is a particularly profound observation but it often seems to get lost in these conversations. It's always about trading risk for expected return.
 
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