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
| Downpayment (30%) | € 60,000 |
| Stamp duty (1%) | € 2,000 |
| Legal fees (1%) | € 2,000 |
| Valuation | € 150 |
| Engineer | € 450 |
| Furniture | € 1,000 |
| Initial investment | € 65,600 |
INCOME
1,500€/month or 18,000€/year
EXPENSES (Annual)
| Mortgage | € 11,632 |
| PRTB | € 90 |
| Insurance | € 350 |
| Life/mortgage protection insurance | € 192 |
| Repairs | € 500 |
| Local property tax | € 200 |
| Refuse | € 270 |
| Total | € 13,234 |
I didn’t include depreciation or accounting costs but those could be included too
CASH FLOW
| Cashflow (18,000-13,234) | € 4,766 |
| Increase in equity * | € 4,953 |
| Total | € 9,720 |
*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
| Income | € 18,000 |
| 100% mortgage interest* | € 6,678 |
| Mortgage insurance | € 350 |
| Repairs | € 500 |
| Profit (Income minus allowable expenses) | € 10,472 |
| Tax at 29.5% | € 3,089 |
| Tax at 52%** | € 5,445 |
*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?
Hi, wait a minute, either I’m way too tired on a sunday or you calculated the taxes as this was the person’s only source of income.
If you are already a PAYE employee and make over 34k(I think) for a single person then the rental income will be taxes at 40% straight away.
Hiya, I included the taxes at 29.5% and 52% for demonstration but used the 52% rate in the calculations as per footnote “**I’m assuming a tax rate of 52% as if you’ve 65,000 to invest you’re probably in the higher tax bracket”. I added the 29.5% rate as this would be the net marginal tax rate for someone earning about 60k or 120k for a couple. For my own rental yield calculations on property, I’m still of two minds about which figure to use. Even though the rental income will be taxed at 52% because your tax credits are used up by your employment income, the net tax rate is still much lower when you take all income and taxes into account. For example: a couple earning 120k combined pays 36k in income tax after tax credit applied (net tax rate of 30%), add 10k of rental income onto that and they pay 41k in income tax after tax credits (31.8% net tax rate). I think using the net marginal tax rate might make more sense when trying to figure out actual rental yield but I wanted to be more conservative in case I am thinking of it incorrectly.