Real estate investments in Ireland need significant capital. In general you can get a loan with a 20% down payment (or 10% in certain cases) when buying a property for yourself to live in. Investment property loans (Buy To Let) start with 30% down payments. It’s a big deal! Before you invest, you should check if it’s worth it. You will be locking down a lot of your capital. You could invest it in other ways, for example in a different real estate deal, equities and so on.
Let’s start with considering how you make money via real estate investment. I see three primary ways:
- Income: cashflow + mortgage paydown
- Appreciation (natural and forced)
- Inflation reducing the value of outstanding debt
Income: cashflow + mortgage paydown
The first one is pretty obvious! If you rent the property it should bring you some income. I divide the income into two parts, cashflow and mortgage paydown. Monthly cashflow is the money you are left with after all the other expenses, taxes and mortgage are paid for a given month. It can be negative if your expenses or taxes are high! Mortgage paydown is the non-interest part of the mortgage. It is how much your outstanding balance on the mortgage is reduced by. During the first years of the mortgage you might be paying more in interest than paying down. You can learn more about it in the article about the mortgage amortization.
Appreciation (natural and forced)
Appreciation means increasing in value. People often expect that the value of real estate should be going up with time. It’s hard to predict how much, but in general it should keep the pace with the inflation. This is what I call the natural appreciation. Is this a reasonable expectation? Well, it depends! You might be investing in an area that is stagnant or is losing population - this won’t help. You also need to remember that the building will also be getting older and the things will break down. We call it depreciation. Sadly you can’t use depreciation for tax deduction in Ireland.
Forced appreciation is when you add value through a smart project. E.g. you buy the scary looking place and you make it shiny again raising its valuation. As long as you don’t underestimate repair costs, you can make a good profit. Popular methods using this technique are Flipping and BRRRR investing.
Appreciation matters in two cases. When you sell or when you are taking the money out of your investment (e.g. by refinancing the mortgage). You need to remember though, that when you sell you might have to pay sizable capital gains taxes.
Inflation reducing the value of outstanding debt while the asset is appreciating
I don’t hear many people talking about it, but getting debt might be quite advantageous due to inflation. This happen when the amount of debt doesn’t keep pace with the property appreciation. How does that work?
Imagine you have 3 properties. Each with 30% down. Let’s imagine that you buy each for 100k. So (simplifying a little) you paid 30k for each and got 70k loans. Let’s imagine that you have an interest only mortgage and let’s ignore the cashflow for now (or assume that it is zero). Interest only mortgage means that you never pay it down, you just keep the amount of debt at the same level. So 25 years later you still have 70k * 3 euros of debt. But the value of assets you control has appreciated! Let’s assume a rate of 4% a year. 100k after 25 years of 4% appreciation will give you about 266k! Now you can sell one of the properties and pay your outstanding debts. This will mean that now after selling one of the properties, can pay off all the mortgages. But, you will be left with two properties free and clear! Or you can sell everything and cash in ~800k, pay your outstanding debt of 210k and be left with ~590k euro. That’s not bad for investing 90! And that doesn’t include money acquired (or lost) through cashflows and paid down equity.
I don’t recommend that you take the interest only mortgage, the same principle works for normal mortgages. Interest only mortgage is just used as a simplified example.
Knowing those sources of returns you can continue analyzing your deal! I’m planning on writing a series of articles about deal analysis. If you have some specific questions, share them in the comments.