Accidental landlord-calculating yield

[Sarenco]

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]

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]

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.

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]

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]

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]

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]

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?

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]

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]

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.