Rising property prices have seen a number of small landlords selling up and getting out of the rental market
I WAS speaking with an accidental landlord recently and I’m not sure she was as accidental a landlord as some people end up becoming.
She told me that when she bought her first property, and that was before she ever got married or had a family, it was always her intention to keep it, regardless of what the future held.
It was never going to be her forever home, but it was going to be her forever pension home, because she saw it as a future asset that she would hold onto long-term, and one that would pay her an income in retirement.
I’m sure there were thousands just like her, who perhaps got married or began living with someone else, or they moved to a different country for work purposes etc. and ended up having this other property they no longer needed to live in, and rather than sell it, they decided to rent it out.
The difference with most in situations like this, I think, is that they became landlords more by accident than design ie. they ended up renting out a property without ever originally intending to, which I guess is the definition of an accidental landlord.
In recent years because property values have risen substantially, many accidental landlords now see this as an opportunity to sell their property and it’s been widely reported that significant numbers of small landlords plan to sell up and get out of the property market over the next five years.
Perhaps they’ve been in negative equity for years and now finally they’re out of it, and now is the time to get out, make some profit, have less hassle with tenants, and better still they won’t have to make that dreaded annual return to Revenue anymore.
They want an easier life, and maybe they’ll make some money from the sale, that can be used to pay down some of the mortgage they have on their new family home.
Their present selves are saying, let’s choose the easy option and sell now, but their future selves are saying, yeah, I get that but what about when we’re older?
There could be lots of reasons why the present self wins out, and for that women I met recently, her thinking was influenced by the fact that for the first time ever the property was going to cost her money each year.
She was always tax compliant and did everything she had to from a landlord's perspective, and she always had good tenants. But from this year on, she was projecting an annual tax bill going forward of about €5,000. And it wasn’t that she couldn’t afford this amount, she was just wondering was it worth paying it?
Would she be better off, selling the property and using that €5,000 and the capital gain she’d have made from the sale, and put that to better use, than just giving it to Revenue each year for the next 22 years (that was the length of time left on her mortgage).
She didn’t know the answer and didn’t want to make a mistake hence the reach out for help.
Her gut was telling her, the easy decision was just to put the house up for sale, it would sell quickly and be done with it, but she didn’t want to learn afterwards that it was the wrong decision for her either.
I didn’t know the answer, so it was time to take the emotion out of her and from our conversation by crunching the numbers.
And it’s always interesting the reaction I get when I’m speaking with people like her, when I begin by telling them what the value of their property is worth from a pension perspective. Because they don’t know what it is.
They know what it might pay them each month, that’s easy, but don’t know how much they would need to accumulate in say a pension fund, that would generate the same amount each year.
If the property was half designed to be a source of income in retirement, then you want to know its value, right?
The property actually has two values, the first being market value which is what you would sell it for and then there’s the value of the property in terms of what you’d have to accumulate in a fund that would pay you the amount you’re currently receiving in rental income each year.
And these two values are two very different things, and I’ll explain the difference between both shortly. But I can tell you now, the market value of her property, was about €270,000 and if she sold it, she’d realize a net, after capital gains profit of about €37,000.
It was time to run the numbers and figure out which option produced the best outcome.
If she sold property and realized that €37,000 profit and invested it along with an annual contribution of €4,951 and let’s be really generous and assume she achieved a gross return of 7% every year for the next 22, and she was taxed at the current exit tax rate of 41%, she’d end up with a fund valued at about €248,610.
And that would pay her a monthly income in retirement using the safe withdrawal rate of 4% of €829.
If she kept the property and it cost her €4,951 every year, in 22 years’ time she’d owe zero.
And let’s assume the rent only increased in line with inflation, meaning she’d effectively have the same €1,850 she has now as she would have then.
If she wanted to generate a pension fund that would pay her that amount each month, she’d have to have a pot with €555,000 in it.
Because when you apply what’s generally considered the safe withdrawal rate from a pension fund which is 4%, that’s what the size of the fund would need to be i.e. €1,850 x 12 = €22,200/4% = €555,000.
So, from a pension perspective, the property was worth €555,000. But from a market value one, it was worth a whole lot less at, €270,000.
And if you ask any investor what the value of their property is, the response is likely to be whatever it pays them each month. Not what its valued at.
It doesn’t matter what the property is worth, whether that’s a million Euros or fifty thousand. What matters is what it pays you each month because that’s real. A paper value is meaningless unless that amount is realized and sitting in your account.
Okay, but what about tax?
Let’s assume she has this gross rental income of €22,200 and let's assume she or her partner has additional income which brings their total income to €40,000, based on current tax rates, at 65 they’ll end up paying 11% in tax.
So, her €22,000 really becomes €19,758 after tax which is €1,647 per month.
Her choices now were:
keep the property, make those forced savings every year of €4,951 and she’s likely to end up with a monthly income of €1,647 per month in retirement OR sell the property and go down the investment route and end up with €829 every month in retirement.
Clearly in this instance, holding on to the property was the best option for her.
This was a bit of an aha moment for her and her husband. They had never thought to the run or think about the numbers like this. And when we did, I think she fell back in love with the property, and maybe that’s a stretch on my part, maybe she just ended up not disliking it as much, I don’t know.
But what I do know, is that payment they were going to make to Revenue, rather than feeling like it was going to be a stone in the shoe cost every year, now they viewed it more as an investment.
If you’re like this women, and it was always your intention to sell the property at some stage, accidental landlord or not, then fine get the For Sale sign up, your timing could be good.
However, if you’re not so sure and you’re wondering whether you should stick with the property for the long run, even if it’s costing you money, before you do anything rash, something you might later regret, run the numbers, or get someone to help you, because they’ll reveal what the best outcome from a financial perspective is going to be, and then you can see if it only fits into your present plans, or perhaps your future ones too.
Liam Croke is MD of Harmonics Financial Ltd, based in Plassey. He can be contacted at firstname.lastname@example.org or harmonics.ie
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