Clearing negative equity: should you hang tight or cash out?

Many accidental landlords who bought apartments at boom-time prices, white-knuckling it through 10 years of negative equity, are now coming up for air. But if the market value of your rental property is at last greater than the outstanding mortgage, should you hold tight or cash out?

For the generation who bought their “starter” home just before the crash, it has been a decade of scary bank statements. As the usual life events unfurled – moving in with a partner, starting a family or pursuing work overseas – paying down debt on a property worth less than its purchase price has been stressful.

For some who became accidental landlords, it has been a decade of playing what must feel like a zero-sum game. Rent has come in, yes, but often gone straight back out again to cover not just the outstanding mortgage but the ever-mounting costs of owning and renting out a property.

Take Sean, a first-time buyer who paid €400,000 for a two-bed apartment in Dublin in 2006. He paid €23,000 in stamp duty on the sale. Valued at €180,000 at its lowest, when Sean needed to move with his expanding family, severe negative equity (the value of the property was less than the amount owing on the mortgage) meant he couldn’t sell. He has been an accidental landlord ever since. Government caps on rent mean the rent barely covers his mortgage. There are ongoing expenses and every October, he pays a chunk of tax on the rental income, crippling his family’s cashflow.

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We are seeing a marked increase in landlords now exiting the rental sector, both accidental ones and small professional ones

While some households remain in negative equity, rising house prices have meant their number has dropped from 40 per cent in 2012 to 5 per cent last year. In Sean’s case, his outstanding debt on the apartment is €220,000. With units in the development now selling for €225,000, he can at last get out. But as the shackles of negative equity fall away, should you stick or twist?

Sell

If you choose to quit, you are not alone, says director of research at DNG Paul Murgatroyd. “We are seeing a marked increase in landlords now exiting the rental sector, both accidental ones and small professional ones.”

He cites the Rent Pressure Zone (RPZ) caps, changes to the legislation around notice periods and hassle as the drivers.

Landlords operating in RPZs cannot increase rents by more than 4 per cent each year. A recent report by Coyne Research highlights frustration among RPZ landlords who feel penalised for having kept rents low before the introduction of the caps and then locked in to a below market rate once they were introduced.

If all of that isn’t enough to make you want to press the eject button, there’s the tax. “In calculating whether a taxable rental profit or loss arises, you need to know which expenses are deductible,” says tax manager at Grant Thornton, Michael O’Brien.

The Residential Tenancies Board (RTB) registration fee, essential repairs and maintenance and wear and tear, advertising expenses and estate agent fees, management fees, rubbish collection, legal/accounting fees and insurance premiums are all deductible. The Local Property Tax is not. From January 1st this year, landlords can deduct 100 per cent of the mortgage interest paid on their rental properties.

If after all of this you have earned a profit, the profit is assessible to income tax at a marginal rate of 40 per cent, PRSI at 4 per cent and the Universal Social Charge at 8 per cent. Compare this to Real Estate Investment Trusts (REIT) – institutional landlords who pay no corporation tax on their profits and gains from rental business in Ireland – and weep.

If you do decide to sell up, well that’s got trickier too. Extended notice periods bring important tenant protection, but for landlords long locked in by negative equity, they are in a further bind. A sitting tenant of one but less than three years must receive four months’ notice if a lease is being terminated. A tenant of three but less than seven years must be given six months’ notice. The rules can risk a costly gap in mortgage repayments should a tenant decide to move on sooner. In addition, a landlord who doesn’t achieve a sale within nine months must give the tenant the option to re-let.

Those selling also need to factor in the cost of sale which the Global Property Guide puts at between 1.2 and 4.3 per cent of the value of the property.

Keep

But is there any merit in riding it out? Hanging on to something you have for so long dreamed of quitting may feel counterintuitive, but is there value in retaining it? Jonathan Sheahan of Compass Private Wealth thinks it’s worth considering.

“What I hear people say a lot is: ‘I’m receiving €1,500 a month in rent but it’s costing me that in the mortgage – 99 times out of 100 that’s completely untrue.

If you are selling because you need to get a new mortgage with your spouse or you want to use the money for something really, really important, then of course do it

“What a lot of individuals aren’t aware of is that they are taking fairly significant chunks off of their principal repayment on a monthly basis.”

He encourages owners to look at their own personal balance sheet. “It’s just the interest that is the cost. The principle [portion of the repayment] is like you are investing tax efficiently every single month in property.”

However, he says it comes down to financial priorities. “If somebody doesn’t have a nest egg, or an emergency fund, or they’ve had their fourth baby and need an extension, then issues like that are far more of a priority.”

While accidental landlords squeezed by income tax and creche fees may struggle to pay the annual tax bill, they need to think carefully before selling. “If you are selling because you need to get a new mortgage with your spouse or you want to use the money for something really, really important, then of course do it. But if you have other sources of income, my default advice to be honest would be keep it.”

Goodbody chief economist Dermot O’Leary agrees that the individual’s financial circumstances are key to the sell/keep decision. “In general, yields on residential property in Ireland are still quite high relative to other assets. At the moment, the gross yield on residential property in Ireland, on average, is around 6 per cent. That’s still quite attractive in the current investment climate.

“Look at what your rent is, your outgoings, your after-tax return and look at how that compares to what you would be getting for your money elsewhere.”

Sheahan says the trend of non-professional landlords buying investment properties to make a profit is gone. Of the stock being sold, there is no march of landlords stepping in to take them up. The flight is highlighted by the RTB’s own figures that show the number of houses for rent fell by almost 2 per cent or about 6,000, in 2018.

But for those prepared to brave it out, that one-time millstone could become a retirement cornerstone. “An investment property can be a great asset in retirement to supplement your income,” says Sheahan. “As you get closer to retirement, it’s about replacing the need to work for your money with earning passively through investments, which is what a pension investment is or what a property investment is.

“One of the fundamental points of financial planning is short-term pain for long-term gain. And there is no such thing as an investment that will be beneficial from a cashflow and a capital point of view all at the same time.”

So while sticking with your negative equity property may feel like Stockholm Syndrome – so long a hostage you develop an alliance with your captor – as a survival strategy, it may be one to consider.