In another post, I looked at how owning and renting out a property usually results in negative monthly/annual cashflow as while the rent pays down your mortgage, you have to pay tax on the principal being paid off even though you don’t realise that pay off until you sell the property, and that’s IF you don’t lose property value BUT I have now found a way that gets you positive cashflow which you can use to pay your living expenses OR build up another downpayment for another property. How? By using an interest only mortgage.

Now I normally wouldn’t have considered using one of these, especially not for my primary residence BUT it does makes sense for an investment from which you want regular income and that’s because 100% of the mortgage interest is tax deductible which effectively gives you 30% more of a return than if you were to go with a traditional mortgage. See details below:

Interest only mortgage option

Assumptions:

• Property value: 200,000
• Borrowed amount: 140,000 (70% loan to value)
• Interest only rate: 5.25% (available through this lender)
• Rental Yield: 1,450€/month or 17,400€/year (annual rent is 8.7% of the purchase price)

Initial investment: 65,600€

• Downpayment: 60,000
• Stamp duty: 2,000
• Solicitor: 2,000
• Valuation: 150
• Engineer: 450
• Furniture: 1,000 (assuming second hand purchases, may be a bit ambitious)

Annual Costs: 9,152€ (includes mortgage, tenant board, home insurance, life insurance, repairs, refuse and property tax)

Tax Deductibles: 8,482€ (includes all of the above excluding property tax)

Profit after tax deductions: 8,648€ (17,400 – 8,752)

Income tax (assuming 33% net rate): 2,854€

Annual take-home: 5,394€

If you manage to find and buy three of these type properties while still working your take home comes to 16,182€ but if you quit regular employment and only rely on the income from the properties your income tax band drops to 18.6% and your net take-home comes to 19,918€ which is close to the national average of annual spending.

Risks

Of course no investment comes without its risks but I do think this particular model is quite risky. To name a few:

• Non diverse, if something goes wrong with the property, like some natural disaster not covered by insurance hits and your capital asset is wiped out
• Rental market could fluctuate. If another recession hits as hard as the last one, rents will have to go down if people can’t afford the current rates wiping out your returns and possibly resulting in negative cash flow
• Managing tenants, potential months where property is left vacant or tenants don’t pay rent
• It’s hard to find a rent ready property for 200,000 that would rent for as much as 1,450/month
• One major repair could cause you to lose a full year or more of income
• Managing a property is hard work and so income is not passive, which could be hard to maintain while you are still working and building up your portfolio
• It’s an interest only mortgage which means you are not paying off any equity in addition to your initial 30%. I’m not sure what that means if you go to sell the property, if there is a capital gain, do you split the profit with the bank? Also not sure how this works if you sell at a loss?

It’s for all of these reasons that even though I personally could potentially retire in the next 3 years using this technique, I would rather work a few more years and invest in the stock market where I could truly get passive income which is well diversified but I thought I’d share the idea in case others who have a higher risk tolerance (or aren’t as lazy) would benefit from it.

Traditional mortgage

But how does a traditional mortgage stack up? Using the same assumptions except that you could get a 4.8% 25 year investor mortgage, and your overall profit would be 10.9% compared to 10.12%, your annual take home would be 36% less at 4,248€ once your income tax rate was down to 18.6%. During your accumulation phase your take home would only be 2,912€ compared to the 5,394€ with the interest only mortgage (56% less) BUT the added benefit is that the principal of the mortgage is being paid off so you are delaying your returns, and as the principal is paid down, your interest also decreases which further reduces your take home over time as you will be paying higher taxes on the principal which the rent is covering.

Other options

There is another option we’ve considered and that was to convert our attic into a 1 bedroom apartment for say 60,000€ and rent it out for 1,000€/month including utilities. This would come to 12,000€/year which you can claim tax free under the rent-a-room scheme. This would be a continual annual 20% return on the initial investment which would pay for itself in 5 years and then every year thereafter would be net profit.

The downsides to that approach are that you’d need to live with someone else, even if they had their own living quarters, you would share an entrance and have noise considerations etc which isn’t something we are prepared to contend with even though it could technically mean I would have the vast majority of my living expenses covered as soon as the renovation was complete and the space rented out.

Also, the renovations may be tricky as there are a lot of codes you need to comply with when converting your attic into a habitable space.

But again, I thought I’d share the idea here in case it does suit other readers. Or maybe your property could be extended to create a granny flat (as long as the addition is attached to your residence it is eligible for the rent-a-room relief).

What about less expensive properties?

What if you could find cheaper properties with lower rents? For example you buy a property in Longford for 70,000€ with initial outlays of 24,000€ and rent it out for 680€/month (annual rent = 9.7% of purchase price), you would need to buy 7 properties to achieve the same take home as the initial example for a total investment of 168,000€. While this is 29,000€ less than the first example, it would require maintaining 4 additional properties.

What about more expensive properties?

What if you buy something more expensive which you get you higher rents? For example Dublin City Centre where the average house price is now 400,000€ and average rents are 2,000€, you would need 4 properties instead of 3 to achieve the same take home, and your total investment would need to be 518,400€ – which means you would definitely be better of investing in the stock market and getting well diversified passive income without all the hassle of managing numerous properties.

The happy medium

If you could find a rent ready house/apartment for 225,000€ and rent it out for 1,875/month, you would only need 2 properties for one person to retire or 4 properties for a couple to retire. Maybe the guide is that if buying an investment property your annual rent should be at lease 10% of the purchase price?

Alternatively you could buy 2 properties and have one person stay home while having their expenses covered while the other person continues to work and invest in the stock market as a means to diversify your portfolio OR you both continue to work and invest together until you have a portfolio big enough for you both to retire.

What about cash purchase?

If you had a lump sum of 200,000€ for the first example, your return on investment would be 6.05% instead of 10.12% and it would take 2 properties for you to obtain the same level of income for a total investment of 400,000€, so again if you had that kind of money it would be better off put in the stock market so you don’t have all the risks and hassles of owning and managing properties.

What about house flipping?

If you are in any way a handy man/woman, flipping houses might be an option for you though I haven’t looked into the rules in Ireland around this yet. In Canada for example you need to live in a house for 3 years before you can sell it in order to be exempt from capital gains tax (this was brought in because so many people were flipping houses and the government was losing too much money).

Check out this video for some inspiration on buying expensive properties in high cost areas and turning them around to make a profit.

Anyway, even though these are not options we are currently considering ourselves, I thought I’d share it as I did the number crunching for my own purposes and hopefully it’s some food for thought for some other investors out there.

Would love to hear your thoughts and any other outside the box thinking you have considered for your investments!

When initially researching the most tax efficient investment vehicles in Ireland for early retirement I at one stage landed on real estate as it seemed like there were the most tax breaks for real estate investors however, on further analysis I have changed my mind. Read on to find out why.

After one of my first quick calculations I thought real estate investing was a no brainer. If I could buy a place worth 200,000 with a 10% downpayment and a 2.95% mortgage rate with an initial outlay of 24,700€ including all purchase costs, then pay about 900/month for mortgage and other expenses and charge 1,500 rent, that’s a take home of 7,150/year divided by the 24,700 investment = 28.94% return before tax * 48% (the government takes 52% at higher income), that still leaves a 13.89% annual return on the 24,700 investment. No brainer right?

Except…

Real estate investment mortgages are only available with a 30% downpayment and subject to much higher interest rates (4.77%) so the initial outlay of 24,700 became 65,600 and the monthly costs of 900 became 1,100 bringing the take-home to 4,766/year divided by the 65,600 = 7.27% *48% = 3.49% roughly after tax. Now there are still some costs that are tax deductible but even with that my calculations bring this to about 5.48% with an annual cash shortfall of 679€ (details below).

5.48% where you need 65,600 cash just lying around to invest in the first place plus you have all your eggs in one basket and subject to much higher risks. Even though market demand and rents are at an all time high, the government has brought in the rent control measures where you cannot increase rent more than 4%/year and can only increase every 2 years and who knows what other laws they will bring it which you will be at the mercy of regardless of your expenses. Local property tax is new and still not included in tax laws regarding allowable deductible expenses – and this charge will only continue to rise. You also have the hassle of being a landlord and keeping on top of repairs and maintenance which are an unknown and potentially exorbitant expense (new roof, new boiler, new appliances if/when they break/are damaged). Not a great return for the risk and time in my opinion.

And now for the math: For a house worth 200,000 borrowing 70% (140,000€) at 4.77%

PURCHASE COSTS

INCOME

1,500€/month or 18,000€/year

EXPENSES (Annual)

I didn’t include depreciation or accounting costs but those could be included too

CASH FLOW

*This is the principal paid off the mortgage by the renter and even though you do not see this cash in hand until you sell (assuming the house does not fall in value) you still need to pay tax on it for the year you received the rent, which can result in the shortfall you see below.

TAX

*Starting in 2019 100% of the mortgage interest will be tax deductible (currently only 85% is)

**I’m assuming a tax rate of 52% as if you’ve 65,000 to invest you’re probably in the higher tax bracket. Taxes on real estate are the same as income tax (40%) and are subject to PRSI (4%) and USC (8%).

TAXABLE EARNINGS

9,720€ minus 5,445 taxes = 4,275€

4,275€/65,600€ initial investment = 6.52%

ANNUAL CASH IN HAND

4,766€ minus 5,445 taxes = -679 shortfall for which you are out of pocket

-679€/65,600€ initial investment = -1.04%

FINAL RETURN

6.52% minus 1.04% = 5.48%

I did see on another blog that some people make voluntary additional contributions to a pension in order to offset real estate taxes but that still leaves you out of pocket on an annual basis in order to make the 6.52% return and you only get access to the pension at 50 at the earliest which is subject to government policy changes too which adds to the risk and reduces your chances of retiring early.

What impact is there on return for cash buyers?

Now you might say, the return would be better for cash buyers but actually it is less as they can only charge the same amount for the rent as the person who borrows and they are putting out a much higher initial investment. When I crunched those numbers, even though the annual cash in hand after tax would be nearly 7,300€, the rate of return for a cash purchase of 200,000€ comes to 3.55%. So even if you had 200,000€ you’d be better buying a few houses with a mortgage on each in order to get the better return if you really wanted to go the real estate route.

Again these calculations assume no increase or decrease in the original value of the property as it could really go either way due to so many external factors. Is it ever worth it?The only time I could see real estate being worth it is if you bought a fixer upper for a small amount of cash and flipped it, but those come with their own risks of unknown expenses involved in the flip etc. There are probably other scenarios that I can’t think of right now but if you think otherwise, please do let me know below!

What do you think? Would you still want to be a landlord if you had that kind of cash to invest?