Buy in haste and repent at leisure…

This article originally appeared in the Sunday Business Post’s new property supplement on the 5th of October 2014.

A vibrant economy must house all people, not just those who aspire to holding a deed in their hand. In late 2013, I was tasked with bidding on a few derelict properties; one had an enforcement order against it, another had been burned out. Suffice to say, these were far from being in any kind of show home condition.

At the time it was believed that the capital gains tax waiver was about to end, and in retrospect it’s probably fair to say that this piece of fiscal policy was behind what happened next.

The properties in question required a huge amount of work and investment to return them to a usable state, not to mention in one case, planning permission. So, the client expected to be able to clear them for very little.

Yet, when we put in a bid there was a higher bid. Then, a third bidder emerged, who went higher yet again. The client stayed in the bidding until it got to the point that you would have to wait about 20 years to get your money back. This is using a cost accounting method of determining break-even points in terms of repayment of capital. Given the risk of property it was a bad choice to continue.

For a while I thought that maybe the property owner, who was in receivership, had gotten friends to bid in order to push up the price, but I heard the same story elsewhere and it occurred to me that this was a fake rush of sorts. People wanted to close quickly – even at a higher price – to get the tax advantage.

This cannot be overlooked – at a time of lowering interest rates money flows into property. But on the capital side of things, consider the following: In 2013, you could buy a property that yielded about 11 per cent; in this example we’ll say that the place cost €500,000, hold that property until 2019 and you don’t have to pay capital gains on any raise in value.

If you were to sell the same property one day, even if rents stayed static, at a return of 7 per cent, which is about the historical average, it would imply the capital value is about €785,000.

That works as follows: €55,000 is your present-day 11 per cent yield, if that same €55,000 represented 7 per cent then the capital amount must be €785,000. Normally, the €285,000 gain made is taxed at 33 per cent and, depending on how future budgets go, this figure could be even higher. That would knock about €94,000 off your gain.

This is key to understanding why property suddenly “bounced back”. It was driven by low rates and government policy designed to make it go haywire, and we have seen how that plan has worked brilliantly so far – if by “working” we mean “prices rose”.

The gain you’d have to make elsewhere to match this would require you to make even more than the €285,000 mentioned. This is known as the taxable equivalent yield, which describes the sum required to get the same amount after tax.

This is another simple calculation. I’ll spare you the workings, but the figure comes out at €425,000. That is the gain you’d have to make elsewhere to get €285,000 after tax.

What does that represent on the original price? A gain of 85 per cent is what it means. The state-backed route to making a compounded return of 9.2 per cent (which is what gives you 85 per cent after seven years) is one that doesn’t cross an investors’ path often, and thus everybody piled in.

The same is happening as 2014 draws to a close and this tax policy is set to end once more, and once again we are seeing buyers scramble to pay over the odds for buildings that can only stack up if they get this tax advantage and price levels generally rise.

Hence the concern that we will see investor activity cool significantly in 2015. This is not a good thing as they tend to be the providers of rented accommodation, and reduced activity won’t resolve the upward price pressure on rents.

A typical Irish bias towards owners may have some people thinking this is a good thing, but a vibrant economy must house all people, not just those who aspire to holding a deed in their hand one day.

The money for housing must come from somewhere, as must the supply of housing, and renters who cannot, or choose not, to undertake the capital outlay of acquisition upon themselves need others to do it for them.

Taken in that wider vista, a lack of investors will be detrimental to the housing ecosystem. We would do well to avoid that, but equally, crazy tax schemes are not the answer.

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