Average salary, borrow to buy a commercial property?

[galway_blow_in]

i recently sold an apartment which i only owned for eighteen months and rented for four months less than that , i realised a gain of 36% and will not have to pay any capital gains tax due to a loss i made on an overseas property which i sold in early 2009

anyway , i have come across a commercial property here the tenant has just entered a ten year lease , the rent is 34k per annum and the purchase price is about 370 k , i would need to borrow 150 k in order to make the purchase , 150 k borrowed over fifteen years will see repayments of 922 per month based on a 5.45% interest rate , rates are higher for this kind of purchase

the alternative to an investment like this is to simply put the money in a dividend paying fund , in this case i would probably see a 10% total return per annum but dividend income would unlikely reach above 6 k on a sum of 225 k

before anyone wants to know where i accumulated this kind of money , i invested in kerry and glanbia in 2010 and made a tidy sum , again i was able to put these gains against the losses on my overseas property which i owned from 2005 to 2009 , i invested in limerick city in 2015 and sold recently

the property im looking at now is a pharmacy

im just wondering if its very high risk , the income is very strong and this to me is attractive as my job is only average and i want to build up a wealth generating asset portfolio , im aware i may be lacking in diversification but unless you have a very large sum to invest, stocks just dont deliver the kind of yields that property does

 

[Sarenco]

Yes, it's a very high risk investment!

You are reliant on the ongoing ability of a single (presumably relatively small) enterprise to pay their contracted rent on an ongoing basis. You can't really compare it with an investment in a widely diversified equity fund.

That's a very decent gross yield of 9% on the figures presented but I don't see how you're projecting a (presumably net) total return of anywhere close to 10%.

In my opinion, income investing is an illogical preference and is typically very inefficient from a tax perspective. But each to their own.

 

[monagt]

In my opinion, income investing is an illogical preference and is typically very inefficient from a tax perspective. But each to their own.

As opposed to what?, investing for capital gain, deposits, divs (income)............

 

[Sarenco]

As opposed to what?

As opposed to investing for capital growth.

Why would you prefer income over capital growth? The tax treatment of income is generally inferior so it seems illogical to me.

 

[monagt]

As opposed to investing for capital growth.

Why would you prefer income over capital growth? The tax treatment of income is generally inferior so it seems illogical to me.

I agree but I presume you don't mean property so are we down to Equities that concentrate on capital growth or what?

 

[Sarenco]

Well, GBI was comparing the yield on an individual commercial property with the yield on a diversified equity fund and this prompted my comment on the (dubious IMO) attractions of income investing.

Bear in mind that capital growth typically reflects anticipated income/profit growth or, increasingly for many companies, paying down debt.

 

[galway_blow_in]

As opposed to investing for capital growth.

Why would you prefer income over capital growth? The tax treatment of income is generally inferior so it seems illogical to me.

As opposed to investing for capital growth.

Why would you prefer income over capital growth? The tax treatment of income is generally inferior so it seems illogical to me.

il explain why for me income is as important

take two assets

a fund with an initial investment of 200 k v a three bed house ( not in dublin obviously ) which cost the same to buy ( assume its bought with cash )

over a twenty year period , the fund is likely to be worth more in capital value , however the house can deliver a gross yield of 7% , twice what the fund can , plus the fund may be worth half its original value after five years due to a bear market in equities , the housing market may also dip during these years but the rent is still delivering a yield of 7%

if someone has a high paying job and has no reliance on income from either a property or an equity fund , then i agree that the diversified equity fund in a wiser investment ( and they would be better with an accumulitive fund as opposed to a distributitive one so as to reinvest dividends ) but you cannot live off the movements in a fund

do you see my point ?

 

[Sarenco]

do you see my point ?

Not really.

With an accumulating fund you can always redeem units to pay for your living expenses.

Money is money. Why would you prefer a dividend over redeeming capital?

There is nothing magical about dividends/rent. If a share portfolio/house falls in value, well, it falls in value. Drawing value from the portfolio/house as rent or dividends (as opposed to redeeming capital) won't change this fact.

I do appreciate that people have a psychological aversion to spending capital (as opposed to the income generated by that capital) but I've never understood the logic behind this preference.

When you consider the differing tax treatments of income and realising capital gains/losses it just seems odd to me.

Just my 2 cent - I appreciate this is not a conventional viewpoint.

 

[Brendan Burgess]

the alternative to an investment like this is to simply put the money in a dividend paying fund , in this case i would probably see a 10% total return per annum but dividend income would unlikely reach above 6 k on a sum of 225 k

Do you own your own home outright? That is, have you repaid your mortgage in full?

If not, that should be your first priority.

my job is only average and i want to build up a wealth generating asset portfolio

What does "only average" mean? If you are paying tax at the top rate, you can get a much better return by investing in a pension fund.

Brendan

 

[galway_blow_in]

Not really.

With an accumulating fund you can always redeem units to pay for your living expenses.

Money is money. Why would you prefer a dividend over redeeming capital?

There is nothing magical about dividends/rent. If a share portfolio/house falls in value, well, it falls in value. Drawing value from the portfolio/house as rent or dividends (as opposed to redeeming capital) won't change this fact.

I do appreciate that people have a psychological aversion to spending capital (as opposed to the income generated by that capital) but I've never understood the logic behind this preference.

When you consider the differing tax treatments of income and realising capital gains/losses it just seems odd to me.

Just my 2 cent - I appreciate this is not a conventional viewpoint.

its an interesting view

i actually prefer equities to property , i just think property delivers higher income from smaller amounts of asset value and some people need to maximise income

i know you could sell off some of your equity portfolio but if you enter a bear market for several years , its hardly wise to do that , with the house or property , you rental income should remain the same even the overall value of the property dips

 

[galway_blow_in]

Do you own your own home outright? That is, have you repaid your mortgage in full?

If not, that should be your first priority.



What does "only average" mean? If you are paying tax at the top rate, you can get a much better return by investing in a pension fund.

Brendan

yes , thankfully i do not have any debt on my primary residence

my income is only 35 k per annum currently from my job but i have a commercial property ( worth 120 k roughly ) which brings in a grand per month and which i pay out 535 per month in loan repayments ( nine years left on a 50 k mortgage ) , i also own some farm land which i receive 6 k per year in rent from , this is tax free under a long term lease scheme

having sold my apartment recently , i have a combined total of 220 k to spend , i already had fifty grand in stocks

 

[Sarenco]

i know you could sell off some of your equity portfolio but if you enter a bear market for several years , its hardly wise to do that , with the house or property , you rental income should remain the same even the overall value of the property dips

I do genuinely understand that perspective but, if you think about it, really what's the difference?

Why would you be happy to use dividend payments on an equity portfolio that is falling in value to fund your lifestyle expenses but balk at realising a capital loss?

Why wouldn't you reinvest your dividends into your equity portfolio if you are concerned about maintaining its (income producing) value?

The same principle applies to real estate.

I would also note that companies can and do cut dividends. And rents do fall. Income on growth assets is never a "sure thing".

 

[Brendan Burgess]

Is this correct?

You have a 50k mortgage on a property worth €120k.
You have a mortgage-free farm paying you €6k tax-free a year
You have €200k in cash
You have your family home

I assume you are single.

You want to borrow €150k to buy a property for €370k

It's very likely that borrowing €150k to buy a property for €370k will work out fine. Your three tenants will continue to pay rent. Property prices will probably rise over the long-term. You will be able to meet your repayments and you will reach retirement owning some valuable income producing properties.

But it could all go wrong. You lose your job. Your tenants stop paying. Interest rates rise. Property prices go into a long-term decline.

It seems much less risky for you to pay off the €50k mortgage (assuming it's not a cheap tracker). You have some taxable income, so contribute enough to stop paying tax at 40%.

Invest the balance in equities.

If the world goes bad or mad, you will be in a very good position owing nothing to anyone.

Brendan

 

[galway_blow_in]

Is this correct?

You have a 50k mortgage on a property worth €120k.
You have a mortgage-free farm paying you €6k tax-free a year
You have €200k in cash
You have your family home

I assume you are single.

You want to borrow €150k to buy a property for €370k

It's very likely that borrowing €150k to buy a property for €370k will work out fine. Your three tenants will continue to pay rent. Property prices will probably rise over the long-term. You will be able to meet your repayments and you will reach retirement owning some valuable income producing properties.

But it could all go wrong. You lose your job. Your tenants stop paying. Interest rates rise. Property prices go into a long-term decline.

It seems much less risky for you to pay off the €50k mortgage (assuming it's not a cheap tracker). You have some taxable income, so contribute enough to stop paying tax at 40%.

Invest the balance in equities.

If the world goes bad or mad, you will be in a very good position owing nothing to anyone.

Brendan

thanks brendan

im not married but myself and my partner have a young child

it ( commercial property ) cost me 122 k all in including stamp duty and legal fees , while not a blue chip tenant , the company has twenty electrical stores around the country , i contributed 72 k of my own money to the purchase , the rent is 1000 euro per month and the sitting tenants lease expires in 2024 , after repayments , i get to keep over 40% of the rent each month , my instinct was to instead of paying off this 50 k loan , to buy another asset as the mortgage is so easily covered on the commercial unit , beit a property or an equity fund , the interest on the mortgage is 100% tax deductible as is the case with commercial property loans

however , i see where your coming from , were i to pay off the current 50 k loan , what i was paying in loan repayments , i could now contribute that exact amount to a pension each month which should deliver the same tax write off as the interest on the current mortgage , that is what you meant , yes ?

 

[galway_blow_in]

I do genuinely understand that perspective but, if you think about it, really what's the difference?

Why would you be happy to use dividend payments on an equity portfolio that is falling in value to fund your lifestyle expenses but balk at realising a capital loss?

Why wouldn't you reinvest your dividends into your equity portfolio if you are concerned about maintaining its (income producing) value?

The same principle applies to real estate.

I would also note that companies can and do cut dividends. And rents do fall. Income on growth assets is never a "sure thing".

if i buy a thousand stocks today at 100 euro each and the company pays 5% of a dividend , provided the dividend is not cut , it doesnt matter from an income POV if the stock price drops to 60 euro at some point , im still earning 5 k per anum gross in dividends from the stock

that is different to doing what you suggest which is selling off a portion of the thousand stocks in order to provide income every so often , if i sell 50 shares in a year in order to provide income , thats ok if the stock price has increased to 120 euro but if the stock has dropped to 60 euro , its not so sweet ?

 

[Sarenco]

Well, if the value of your stock portfolio falls in half and the dividend yield per share remains constant your income also halves.

I don't think we're ever going to see eye-to-eye on this one but I hope you can at least partially see my point that there is nothing particularly "magical" about dividends (or any other source of income) to contrast it with capital gains.

Leaving the theory to one side for a moment, what interest rate are you paying on the €50k loan? Paying that off may well be the best use of your capital on a risk-adjusted basis.

As a suggestion, it might be worth aiming to divide your investable capital in three (very roughly) equal "pots" allocated to real estate, equities and cash/State Savings products. With zero debt, that should allow you to sleep well at night without worrying unduly about inevitable market gyrations.

It sounds as though you are already in decent financial shape and there's really no need to needlessly "stretch for yield". Protecting your accrued wealth is an equally important consideration.

 

[Brendan Burgess]

im not married but myself and my partner have a young child

All of this argues for minimising your risk and maximising your liquidity.

If you need cash suddenly, you won't be able to sell a bit of one of your buildings.

You should pay down your mortgage, and invest the balance in equities. If you need cash, you can then sell some of your equities.

Brendan

 

[galway_blow_in]

Well, if the value of your stock portfolio falls in half and the dividend yield per share remains constant your income also halves.

I don't think we're ever going to see eye-to-eye on this one but I hope you can at least partially see my point that there is nothing particularly "magical" about dividends (or any other source of income) to contrast it with capital gains.

Leaving the theory to one side for a moment, what interest rate are you paying on the €50k loan? Paying that off may well be the best use of your capital on a risk-adjusted basis.

As a suggestion, it might be worth aiming to divide your investable capital in three (very roughly) equal "pots" allocated to real estate, equities and cash/State Savings products. With zero debt, that should allow you to sleep well at night without worrying unduly about inevitable market gyrations.

It sounds as though you are already in decent financial shape and there's really no need to needlessly "stretch for yield". Protecting your accrued wealth is an equally important consideration.

your dividend income doesnt fall just because the capital value of the stock - portfolio slips

good dividends are the only comfort during bear markets which happen in stocks more often than property , anyone who owned coca cola or procter and gamble from the year 2000 to 2010 , still had a 3% dividend yield to cushion the blow of one fairly bad bear market from 2000 to early 2003 and the worst since the thirties from late 2007 to spring 2009 , thats 30% over ten years , better if you reinvested dividends instead of taking the cash

dividends make the likes of johnson and johnson better than the likes of netflix over a very long time

 

[galway_blow_in]

All of this argues for minimising your risk and maximising your liquidity.

If you need cash suddenly, you won't be able to sell a bit of one of your buildings.

You should pay down your mortgage, and invest the balance in equities. If you need cash, you can then sell some of your equities.

Brendan

im not someone who is paying tax at the higher rate on too much of my income but if i were able to gain as much tax reduction through a pension as i am on the interest deduction on my mortgage , i will pay off my mortgage , i will talk to an accountant about it in detail

 

[Brendan Burgess]

im not someone who is paying tax at the higher rate on too much of my income

So just pay enough pension to use up the bit you are paying higher rate on.

if i were able to gain as much tax reduction through a pension as i am on the interest deduction on my mortgage

It's hard to explain, but this is not a valid comparison. If your lender puts up the interest rate to 10%, you will get a much higher interest deduction on your mortgage. By your reasoning, then you should not pay down your mortgage!

So it's actually the opposite. If you are on a cheap tracker, you should not pay down the mortgage, despite the fact that the tax deduction on the interest is so small.

Brendan