Returns on rental property

VonLuck

I'm currently considering purchasing a two bed property and am trying to work through all the various scenarios which could happen in the future. I intend on living in the apartment, but letting out a room tax free under the rent a room relief scheme.

That's all well and good, but say in 5, 10 or 15 years I decide to purchase a second property to live in and rent out the apartment, what kind of yields am I to expect?

I worked through the figures (which I think I understand correctly) but am coming up with quite low returns. Let me just give you the figures I'm working with, both living and renting a room and renting out the whole apartment:

Owner Occupied and Renting Room
Insurance/Property Tax/Maintenance/Management Fees = €315
Mortgage Interest (roughly 3%) = €265
Total Monthly Cost = €580

Income From Renting a Room = €675

Net Gain = €95

Renting Whole Apartment
Property Tax/Maintenance/Management Fees/Letting Fees (not sure if letting agent is necessary) = €410
Mortgage Interest (roughly 5% for investment property) = €445
Total Monthly Cost = €855

Rental Income = €1225 (conservatively assuming 1 month vacancy a year)
Taxable Income = €520 (on the basis that letting fees, maintenance, management fees and 75% of mortgage interest are not taxable)
Tax (taken at higher bracket 51%) = €265

Net Gain = €105

I estimated the gross yield on renting the whole apartment to be 5.9% and the net yield to be about 1.7%. The extra cash in my pocket is only €10 compared to just letting out a room! Now to me that doesn't seem all that great.

Am I missing something in my calculations, or are these the kinds of returns I would expect?

scoobydude

You need to remember that in 30 years or whenever the mortgage is paid off you have an asset with a few hundred thousand euro

Samuel T. Cogley

For the tenner you assume the risk of someone refusing to pay, it taking 18 months to get them out and they wreck the place. So factor that in.

VonLuck

scoobydude wrote: »

You need to remember that in 30 years or whenever the mortgage is paid off you have an asset with a few hundred thousand euro

Yes, but this is the case in both scenarios, but with the second you also have the additional cost of having to live somewhere else, so that's a second mortgage / rent which is already taken account of if you're just renting out a room.

Samuel T. Cogley wrote: »

For the tenner you assume the risk of someone refusing to pay, it taking 18 months to get them out and they wreck the place. So factor that in.

Oh I'm well aware. That's why I thought my figures were off as the risk / reward didn't seem to be worth it.

Caranica

Why are you including mortgage interest, property tax etc in the expenses of renting a room. There's 0 difference in those expenses by having a lodger or not?

VonLuck

Caranica wrote: »

Why are you including mortgage interest, property tax etc in the expenses of renting a room. There's 0 difference in those expenses by having a lodger or not?

I suppose you're right. These are really costs associated with my own living expenses. That makes the whole apartment rental option seem even worse!

This is why AirBnB is so popular. Also why there is a housing crisis. Not the money grabbing landlord myth.

VonLuck

So what I'm taking from this is that my calculations aren't really that off and that there's not much to be gained becoming a landlord?

krinpit

While you may not have extra spending money in your pocket each month, you will be gaining equity that someone else is paying for.

Peregrinus

VonLuck wrote: »

So what I'm taking from this is that my calculations aren't really that off and that there's not much to be gained becoming a landlord?

There's potentially a large amount to be gained. Your calculations of return on your investment ignore the residual value of the asset when the mortage is paid off, whereas in fact that is where the bulk of the return is expected to be found. This is like calculating a return on an investment in shares by just looking at the dividends you will get, and ignoring the rise in value in the shares, and the ultimate sale proceeds.

VonLuck

Peregrinus wrote: »

There's potentially a large amount to be gained. Your calculations of return on your investment ignore the residual value of the asset when the mortage is paid off, whereas in fact that is where the bulk of the return is expected to be found. This is like calculating a return on an investment in shares by just looking at the dividends you will get, and ignoring the rise in value in the shares, and the ultimate sale proceeds.

Well in both scenarios the increase in asset value is the same, hence discounted. Renting out a room appears to actually have a much greater return as this covers your accommodation expenses, whereas in the other scenario you still need to factor in rent or a second mortgage.

Peregrinus

VonLuck wrote: »

Well in both scenarios the increase in asset value is the same, hence discounted. Renting out a room appears to actually have a much greater return as this covers your accommodation expenses, whereas in the other scenario you still need to factor in rent or a second mortgage.

Renting out a room has a larger gain because it is tax-favoured, but of course the tax break is limited in amount so, the more you are investing in your property, the less (relatively speaking) benefit you get from the tax break.

The other consideration - non-financial, but maybe very signficant - is that to use the rent-a-room scheme you have to forego privacy in your own home, which may not suit you. And, even if it suits you now, it may not suit you for the entire length of the mortgage. So I think there's more than just tax and investment return to be considered here.

Graham

VonLuck wrote: »

Well in both scenarios the increase in asset value is the same, hence discounted.

It's not just the increase in asset value that you're gaining. The asset is being bought for you.

Even if asset values don't increase, you still own the asset at the end of the mortgage. That's quite possibly the largest part of the return.