Investments in real estate are stable and reassuring, offer safe returns and present limited long-term risks. It’s therefore no surprise when individuals, investors and companies choose to invest in bricks and mortar rather than the stock market. However, making a successful real estate investment isn’t easy. Type of financing, tax optimisation, applicable laws and practices… ensuring the success of the project means mastering a wide range of subjects. This is why expert advice is a must.
By studying these 10 tips and pitfalls to avoid, you’ll help ensure your rental investment is a success.
Sentimental attachment, ease of transaction, wealth and estate planning strategy: for many reasons, homeowners vacating their main residence may decide to rent it out rather than sell.
However, this isn’t necessarily the best choice, since capital gains on a main residence aren’t taxable. If you rent out your property, it’ll be treated as a rental investment, and when you do come to sell, the capital gain will be taxed at half the overall rate. From a financial perspective, it’s often better to sell the property and reinvest the proceeds in a property with a more favourable tax treatment.
What types of property have the best tax treatment? In Luxembourg, there are four different types of property: off-plan sale projects, new builds, buildings over five years old and buildings over 60 years old.
Tax treatment varies according to the property type. Registration fees for off-plan sale projects apply to the land portion only, considerably reducing the amount due (approx. 60% less). Another important factor is the annual depreciation rate. This stands at 5% (with a special property allowance of 1%) for the property’s first five years, and then falls to 2% until the property is 60 years old. The difference is significant. Properties over 60 years old depreciate at a rate of 3%.
Therefore, the three types of property that we recommend are off-plan sale projects, new properties up to five years old, and properties over 60 years old which require major renovation work (subsidised when it improves energy performance) that is deductible or depreciable for tax purposes.
(…) while prices per square metre fall as you get further from the city, bear in mind that rental demand and, above all, the prospects for price increases and resale fall as well.
A property’s location has a direct impact on the returns it generates and its resale potential. While prices per square metre fall as you get further from the city, bear in mind that rental demand and, above all, the prospects for price increases and resale fall as well. However, the rental returns may be higher than for investments in the city.
Also, to allow for price increases, it’s advisable to purchase properties with good resale potential. Aim for one- or two-bedroom flats near the city and take time to choose the best on offer (orientation, floor in the building, etc.). Where possible, think long term (e.g. will your children live in the property?), and more generally, since efforts made now will pay off down the line.
A good source of financing reduces costs while limiting risk. The best formula thus depends on your goals (speculation, return over a given period, portfolio creation) and the type of property being financed. A mix of different loan types (fixed-, variable-, or adjustable-rate) is often the best solution.
Once applicable tax deductions are taken into account, the real cost of the loan can be as low as 60% of its face value, which can partially offset any rate increases.
In rental investment projects, the question of furnishing almost always arises. Note that while furnished properties are more liquid, since they have very high demand, they tend to see higher tenant turnover. The clear advantage is that you can charge higher rent, and with fewer restrictions (see section 6).
In any case, make sure to check fixtures and fittings on the tenant’s arrival and departure to ensure that everything is being returned in its original condition. The rent guarantee (two months’ rent on average) will insure you against any damage.
For a property to be considered furnished, it must be fully equipped. It’s not enough for the property to have just a bed, a table and a chair.
Note: for a property to be considered furnished, it must be fully equipped. It’s not enough for the property to have just a bed, a table and a chair. Repetition and used immediately afterwards!
Setting the rent is a balancing act. Too low and you won’t get the best out of your investment, too high and you risk tenant turnover and months without a tenant, significantly harming your return. The only solution: set your price based on the rents charged for very similar properties in similar areas. At present, rental returns in Luxembourg vary between 2.5% and 3%. Bear in mind that in Luxembourg, annual rental returns may not exceed 5% of the capital invested in the property (or 10% for furnished properties).
The draft reform of the legislation on rental leases provides for a maximum annual return of 3.5% on the capital invested, or of 3% for properties with an energy passport lower than class E. However, it should be noted that new revaluation coefficients that more closely track the evolution of housing prices will be introduced, benefiting owners.
In Luxembourg, the law allows you to adjust rents every two years. This adjustment must be provided for in the contract in a set format and follow a specific procedure. However, pursuant to the 2006 law in force, the rent may not exceed 5% of the revalued and discounted capital investment.
The draft reform of the legislation on rental leases gives more leeway in these biennial adjustments. However, if the rent is adjusted by more than 10%, the increase will have to be divided into three parts and spread over two years.
We strongly advise seeking help from a professional when searching for a tenant. (…) Unless otherwise agreed, agency fees in Luxembourg are borne by the tenant.
Should you list with an agency? We strongly advise seeking help from a professional when searching for a tenant. This has a number of advantages: it simplifies the process, you don’t have to organise visits, and you get real guidance and expertise.
The draft reform of the legislation on rental leases provides for agency fees to be shared 50/50 between landlord and tenant.
What about rental management? Here again, an agency can deal with all the tasks arising from your rental investment: collecting and pursuing rent, organising any repairs, managing the administration, etc. This service usually costs one month’s rent. You decide whether you want this convenience, but given the price, make sure you choose the agency carefully.
In addition to the non-payment of rent, where you can evict a tenant via legal proceedings, there are two specific situations in which you can recover your property:
In other cases, bear in mind that it’s not possible to evict the tenant, even where the lease is fixed-term. Instead, you’ll need to negotiate with the tenant and find an amicable solution.
Firstly, bear in mind that capital gains on the sale of property owned for less than two years are considered speculative gains. The progressive tax scale will therefore apply (max. 42%, excluding contribution to the employment fund). On the other hand, capital gains on the sale of property owned for at least two years are treated as profit on disposal, which is taxed at half the overall rate, and to which are also added deferral measures. It’s therefore best to hold on to your investment for at least two years.
So, when should you sell? From a purely financial standpoint, it’s better to sell your property once it’s more than five years old. As explained in section 2, the annual depreciation rate drops from 5% (with the special property allowance) to 2% between years five and six. Financially, it’s therefore preferable to switch to a new property that will allow you to once again benefit from the accelerated depreciation rate of 5%. However, this means finding a replacement property in a location with high potential. Here, as with everything, “the art of success consists in knowing how to surround yourself with the best.”
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