Yield Signs

This week daft.ie issued its Quarterly Rental Price report highlighting yet again the shortage of rented residential accommodation stock on the Irish market.  

In the context of the yields being quoted in the same report, that's an extraordinary finding.  You can apparently get a yield of up to 12.5% on a one-bedroom apartment in Dublin 17.  So in this age of negative interest rates and faltering stocks, why aren't people flooding into the residential market in search of a better return on their cash?  Why should it be the case that, if as the Irish Property Owners Association claims, landlords are leaving the market rather than entering? 

A gross yield in the order of 12.5% per annum (that’s up to one eighth of the capital invested) is colossally attractive as an investment proposition.  However there is a world of difference between gross yields and net yields.  A world of difference in this case means that the net yield is possibly less than half the gross yield for a landlord paying tax at Irish marginal rates (including PRSI and USC) of 52%.  

It is indeed true, as the Daft report clearly illustrates, that it can be cheaper to be paying off a mortgage than to be paying rent, and this holds good for many different types of property in many areas of the country.  This though is solely from the tenant’s perspective.  From the landlord's perspective, the cost of servicing the debt on a mortgaged property is paid out of after-tax rental income.  The Irish tax system conspires to ensure that the after-tax amount for a private investor in rented residential accommodation is as little as it possibly can be. 

It's ironic that this is particularly true in a low interest environment.  Interest charges on property are one of the biggest tax breaks for landlords, to the extent that these were restricted in times gone by.  Now with interest rates so low, far more rental income falls within the charge to tax each year.  The interest paid used to largely extinguish the tax charge and thus the cash flow burden of renting out a property.  You always had to pay the bank and the Revenue, but rarely both in the early years of a mortgage.  Just like any other business, when renting property cash is king.  Too much of a negative cash flow will swamp any capital yield, no matter how attractive the yield might be. 

Nor is it possible to offset the capital cost of a property against the rental income arising from it.  This wasn’t always the case.  Offsetting the capital costs against rental income to wipe out the tax bill was the essence of the so-called “section 23” properties which first surfaced in the 1980s.  That incentive made property investment from private individuals very lucrative, while at the same time dramatically increasing the supply.  But the country overdid it a bit and left the relief in place for too long.  This contributed to the property crash in 2008. 

In fact we may now have gone to the other extreme when it comes to the rigours of the regime for taxing rents from residential property.  There are several restrictions on the tax deductibility of costs associated with property for rental.  There is only an annual deduction for one eighth of the cost when it comes to items like replacing appliances.  A new dishwasher in a rental property costing €400 provides an annual tax saving of less than €30 for the landlord. 

All these restrictions apply because generally speaking, income from rented residential property is ring fenced from other income and allowances, and is subject to a special set of rules all of its own.  Residential property is not the only type of property that has its own set of rules, but they are tough in comparison with those which apply to other types of property.  

Take, for example, the way farm buildings are treated for tax.  A farmer gets a tax write-off of 15% of the capital cost of a milking parlour or a hayshed, as well as full tax relief for interest paid on any borrowings to build it.  Even if a farm building is inherited, a lower rate of inheritance tax is charged, provided that the farming business continues on.  

It is bizarre that it is more tax efficient in this country to provide housing for an animal than it is to provide housing for a child. 

The Irish rented residential market, provided you have the capital in the first place, can be a solid investment proposal.   Otherwise, despite its high yields, it can be a money pit when a rental property is heavily indebted.  Tax is not the only reason for the shortage of supply of accommodation, but it is undoubtedly a factor. 

Dr Brian Keegan is Director, Public Affairs at Chartered Accountants Ireland