Buying new house should I sell investment property ?

[beekeeper]

I am hoping to buy a family house in the coming months. I have a investment property which is still in negative equity. I have however paid off a lot of the mortgage over the years and have a very nice tracker rate. Thankfully, I don't necessarily need to sell this property. It would however take a lot of pain away from our new mortgage. I will outline below some details and would appreciate any comments or advice.

New house c. 900k
Savings 150k
Investment house worth 400k
1600 per month rent
Investment house mortgage remaining 200k (.75% tracker)

In simplistic terms I can either sell the house and get a 550k mortgage or keep the investment property and get a mortgage for 750k.

Myself and my wife, thankfully have very good jobs so can get either mortgage

 

[Protocol]

I don't have an answer for you, sorry, but just one point:

Negative equity means the house value is less than the mortgage balance.

Your BTL house value is 400k, and the mortgage balance is 200k.

So you have POSITIVE equity of 200k.

 

[Delboy]

I presume your saying that the investment property is now worth less than what you initially paid....though that doesn't mean your in neg equity

 

[dub_nerd]

Apart from the issue of being quite exposed to property with two houses, the question boils down to where is your €200k giving the best return. There are two ways of looking at it: one looks at the total costs over the life of both mortgages and the fact that you have an asset at the end if you don't sell the investment. But a lot of things can happen in the mean time. The second (which I've seen BB on here advocate) is much simpler and more sensible -- look at what it's going to cost you this year. You can always review again in future.

If your new mortgage is at, say, 4%, then you will pay €8k interest on the €200k that could have been freed up by selling the investment. You will take €19.2k in rent. On the face of it, keeping the investment makes sense, but you will need to reckon yourself the cost of the 0.75% tracker, expenses and tax on your rental income, and see if the balance still favours keeping the investment.

 

[Fin Crusader]

Firstly , was this house your home, or was it always an investment property ? If the answer is the later, when you sell the house you may be liable for capital gains tax depending on what price you originally paid for the property. However if you live in the house for a year this liability can be reduced as it would then be deemed your principal private residence by revenue, you should also enquire does your bank have a moveable tracker product.
If I was in your situation I would try and hold on to the investment property as your tracker at ECB+.75% is gold dust and you will never get a rate like that again.

 

[Sarenco]

On the figures presented, it seems pretty clear cut to me that the OP should sell the rental property in order to take out a smaller mortgage on the new house.

Rental income of €1,600 per month on a property valued at €400,000 equates to a gross yield of 4.8%. However, if you account for all costs, actual and imputed, the property is unlikely to achieve a net yield of more than around 3.5% per annum, on average, before financing costs and income tax. Costs would include voids, management/letting agent commissions, insurance, repairs and maintenance, advertising, accounting, legal, LPT, PRTB, refuse collection, etc. Even if the OP manages the property himself he should still account for his time in calculating the average net yield. A net yield of 3.5% is less than the cheapest variable rate mortgage currently on the market so financially it makes more sense to sell the rental property and take out a smaller mortgage on the new property.

Look at it this way - which would you prefer, a guaranteed, tax free, net yield of circa 4% (which is effectively what the OP would achieve by taking out a smaller mortgage) or a risky, taxable, net yield of circa 3.5% (which is roughly the net yield that the OP currently achieves on the capital tied up in his rental property)?

The fact that the rental property is financed by way of a cheap tracker does not change the fact that a better return can be achieved elsewhere.

You then have to consider income tax. While most of the costs listed above are tax deductible, it is important to note that the LPT and 25% of all mortgage interest payment are not deductible. This will be material as the OP almost certainly has a high effective rate of income tax (which includes USC and PRSI for this purpose).

CGT is obviously not an issue if the rental property is sold for less than its acquisition cost.

 

[dub_nerd]

Rental income of €1,600 per month on a property valued at €400,000 equates to a gross yield of 4.8%. However, if you account for all costs, actual and imputed, the property is unlikely to achieve a net yield of more than around 3.5% per annum, on average, before financing costs and income tax... A net yield of 3.5% is less than the cheapest variable rate mortgage currently on the market so financially it makes more sense to sell the rental property and take out a smaller mortgage on the new property.

Not sure this is the right way to look at it. Only €200k of the value of the investment house belongs to the OP. The rest is borrowed at an incredibly low rate of under 1%. A return of 3.5% on this portion is pure profit, which cannot be translated over to the other mortgage since the tracker is not transferable. I think the only fair way to look at it is the net effect of leaving the OP's €200k where it is, or moving it to the other mortgage. Also, in counting financing costs, only the interest portion of the mortgage on the investment property should be counted, i.e. 1% of the outstanding €200k, or whatever it is. The rest is paying capital. I agree he should look closely at his income tax which might erode the value of the investment significantly.

 

[Sarenco]

Not sure this is the right way to look at it. Only €200k of the value of the investment house belongs to the OP. The rest is borrowed at an incredibly low rate of under 1%. A return of 3.5% on this portion is pure profit, which cannot be translated over to the other mortgage since the tracker is not transferable. I think the only fair way to look at it is the net effect of leaving the OP's €200k where it is, or moving it to the other mortgage. Also, in counting financing costs, only the interest portion of the mortgage on the investment property should be counted, i.e. 1% of the outstanding €200k, or whatever it is. The rest is paying capital. I agree he should look closely at his income tax which might erode the value of the investment significantly.

Ok, look at it this way so:

Ignore income tax for a moment and let's say you have €200,000 in cash. Would you chose to use the cash to pay down a mortgage of €200,000 at a fixed-rate of 4% per annum over a particular period or would you buy a bond that pays a fixed coupon of 3.5% over the same period? Ignoring liquidity considerations, you would obviously pay down the mortgage. Now let's say the source of that €200,000 in cash is a loan at an incredibly low rate - 0% for example - would that change the decision?

Now let's say income tax reduces the after-tax yield on the bond by, say, 50% to 1.75%. I would suggest that paying down the mortgage now becomes the very clear winner.

Exactly the same analysis applies to the OP's scenario. The question is really whether he should realise the €200,000 equity in the rental property and use the cash to discharge part of the acquisition cost of the new house in order to avoid taking on a loan of €200,000 at 4% or continue to leave the €200,000 equity tied up in asset that is yielding 3.5% pre-tax (and much less on an after-tax basis).

Financing a low yielding asset cheaply doesn't turn it into a higher yielding asset.

The only logical reason you leave the €200,000 tied up in the rental property in these circumstances is because you want to increase your leveraged exposure to the underlying asset class (residential property) in the expectation of capital gains. This forum is littered with posts from people who found themselves on the wrong side of that particular bet in recent years.

 

[dub_nerd]

Ok, look at it this way so:

Ignore income tax for a moment and let's say you have €200,000 in cash. Would you chose to use the cash to pay down a mortgage of €200,000 at a fixed-rate of 4% per annum over a particular period or would you buy a bond that pays a fixed coupon of 3.5% over the same period? Ignoring liquidity considerations, you would obviously pay down the mortgage. Now let's say the source of that €200,000 in cash is a loan at an incredibly low rate - 0% for example - would that change the decision?

Now let's say income tax reduces the after-tax yield on the bond by, say, 50% to 1.75%. I would suggest that paying down the mortgage now becomes the very clear winner.

No, this is incorrect. The €200k is not yielding 3.5%. The €400k is yielding that. Half of that money is borrowed at 1% and is making a €5k pre-tax profit. The equity half is making €7k pre-tax profit, but losing the 4% (€8k) that would be avoided if he offset the other mortgage. The net position is that he is €4k better off keeping the investment, pre-tax. He needs to look at the tax situation to see which is actually better.

The whole thing is much simpler if he just calculates the net costs/profits on the whole thing as per my first post (#4 above).

 

[marathonic]

I agree with dub_nerd. This is in no way similar to an investment in a €200k bond at 3.5% because the entire €400k is invested whilst selling and buying a bond would only result in a €200k investment.

What I tend to do in these situations is to do up a forecasted tax return to calculate your estimated overall profit after tax. Then, deduct the interest paid on a €200k portion of your home mortgage as an 'imputed expense'. If you're left with a positive figure, it's worth considering keeping both properties.

I don't like to include the impact of capital appreciation in my calculations because I'm not a fortune teller.

 

[marathonic]

In the example above, the €19.2 income stream from rent is costing the op €1500 in interest on the loan secured against the property. Let's use an estimate of €3700 for other expenses. The profit before tax is €14k here and roughly halving this due to the impact of taxes leaves €7k profit (obviously calculations here will be subject to the ops personal circumstances).

The 3.61% rate achievable with KBC means that the additional €7220 interest paid on the ops additional home loan mortgage borrowing will just about be covered by the net profit on the rental property, i.e. the decision to keep or sell it is in no way clear cut. Other factors must be considered. For example, the op may see an early retirement for one/both partners. This would reduce, or eliminate, the taxation from the above calculations. The op may also have their own opinion on the future direction of house prices.

 

[Brendan Burgess]

This is a really interesting question, and I am not sure of the answer. The only way is to crunch the actual numbers.

First question though - was the investment property your home at any stage? If so, would the lender allow you to mover the tracker to your new home? If so, then I would be fairly sure that selling the property would be the right idea. But do the numbers to check.

So it's clear to me that you should sell the investment.
If you can transfer the tracker, it's even clearer.

Even though you have very good incomes, €900k is enough exposure to the property market, and a loan of €550k or 61% LTV is a big enough exposure, so this also suggests selling the house.

The smaller loan gives you so much more flexibility. If you want to switch lenders for a better deal later, other lenders will be much hungrier for your business.

It's important to sell the property before you buy your home, so that your initial Loan to Value is as low as possible.

Does CGT matter?
I am not sure, but as you seem to have lost money on it, it's not that relevant.

Don't forget that selling it at a loss gives you a loss for CGT purposes which you may be able to use against gains at some later stage.

Brendan

p.s. Does the new format not have a button for "Best answer" ?

 

[Sarenco]

I take the point that there is actually €400k invested at a net yield of 3.5 per cent, of which €200k is borrowed money. I ignored the effect of leveraging on the net yield to make the broader point re debt avoidance.

A net yield of 3.5 per cent (as against a gross yield of 4.8 per cent) on €400k implies operating expenses of €5,200. Using that figure, it is still clear to me that it makes sense to sell the rental property, even before taking income tax into account (because the leveraged net yield on the €200k equity tied up in the rental property is lower than the best rate available on a new loan of €200k). The difference is obviously sensitive to the net yield and interest rates figures used but in any event the impact of income tax significantly favours selling the rental property.