The issue with Irish property (in particular Dublin where demand is evident) is that the pump has been primed in many different ways, first we’ll look at ‘how’ and then we’ll look at the aftermath using a worked example.
First of all, here are some of the things that are driving the market…
1. Build up of buyers, be they first time buyers or REIT’s who are able to take up any available supply.
2. ECB rates are low, yield searching is an issue, deposit rates are low as is the risk free rate by comparison.
3. Tax policy is an issue, from 2014 the marginal rate applies meaning that in a few short years the tax has gone up by 105% on savings from 20% to 41%.
4. Finally, there is the Capital Gains Tax waiver if you buy a property and hold it for 7 years.
So here’s a worked example of the massive give away this represents and why it is mobilising so much money into property. We’ll take an identical €200,000 make a comparison over 7yrs from 2014 and look at the bottom line difference using a revised yield model.
First, if you put €200,000 on deposit at 2.5% (which you won’t get but we’ll say you can for this example) you’d be getting €5,000 in interest in year one less €2,050 in DIRT. Compounding annually and taking away annual DIRT for 7 yrs your lump sum would be worth €221,587 which represents a net return of about 11%.
Now onto the property proposition, you can still buy property yielding 9% and more, if you were to do that you’d be getting €18,000 less about 60% (there is USC, PRSI, PRTB, property tax which isn’t offsetable and other costs so we’ll round it to about 60% tax which will allow for some vacancy too) which is €7,200 per year for 7 years which gives you €50,400.
Then the kicker, there is likely to be some rental growth, relative to your initial yield (we won’t factor that in but imagine it goes from €18,000 a year to €20,000 and you then sell the property on the basis that it is making a 7% yield. The maths of that is 20,000/0.07=285,714 and the 85,714 gain is not taxable.
Property (and CGT calculations) has some costs of acquisition and disposal that would come off that amount anyway, but for sake of ease you now have 85,714+50,400 which gives you €136,114 of a return!
A great way to think of it is this, to get €85,714 after tax (assuming the 41% rate) you’d have to make 85,714/1-(taxrate) which is 85,714/1-.41 = €145,280 elsewhere to match it. Even if you did this with stocks you’d have a sum of about €128,000 because the CGT rate is 33% (same calculation as above but with 0.67 as the denominator).
So as Paddy Punter do you keep your money on deposit, get back 11% net and have an additional €21,587 in hand after tax or do you put it into property and have €136,114 (over 6 times more!) in hand?
And when you look at the tax equivalent yield (which once again, is what you’d have to make elsewhere to match it) it’s more like 145,280+€126,000 (gross rent) which means you’d have to be making €271,280 to do as well, and let us not forget that’s the bit on top of the 200k initial outlay, and nowhere are you likely to get that, not even in crazy high risk equities because frankly 136% returns are hard to come by.
So when you wonder why property prices are rising it’s worth remembering that when you mix all the taxes, returns, yields and the like that it boils down to this: Deposits will get you about €20,000 and a property will probably get you the pre-tax equivalent €271,180.