These days, investors are staying away from the apartment market. A series of tax penalties introduced by the Government as a result of successive Bacon reports has stopped virtually all investment activity in the residential rental market.

The main deterrent has been the Government's decision not to allow investors to offset rental income against their mortgages, forcing them to pay tax on all rents. On top of that, investors are obliged to pay 9 per cent stamp duty on residential properties aimed at the rental market.

Unless investors manage to capture one of those increasingly elusive Section 23 properties - and even with these units, investors are still caught in the tax net on rents - they are staying well away.

It's hardly surprising that the market has taken a serious hit. A look at the losses sustained in the initial years of investment is sobering. Any investor taking the plunge would have to subsidise a property to a significant extent. The reluctance to do so has served a body blow to the apartment market and developers are either holding off on building new apartments or are having to cater for the owner-occupier. There is now a chronic shortage of middle range properties on the rental market, a fact which the Government is going to find increasingly difficult to ignore.

At the end of the first year of purchase, substantial losses are inevitable for the investor, when entry costs, including the capital needed to buy the apartment, stamp duty and legal costs are taken into account, and when mortgage repayments and tax is deducted from rental income. Maintenance and fit-out costs add an average of £12,000 to £15,000, though some of it can be written off against tax.

Long-term gain will largely depend on future levels of capital appreciation, which nobody can predict with certainty, and that in turn is influenced by the location of the apartment. Industry analysts believe that there will be a maximum growth in the market of between 5 to 8 per cent per annum up to 2005. Calculating how an investor will fare over an extended period is difficult, because of the number of imponderables. Rent levels are likely to continue to rise as long as the supply remains tight, but with the Government under increasing pressure to intervene, investors will inevitably be back at some stage in the future and this will increase supply and curb rents. Stamp duty could be reduced and investor taxation levels could vary.

Other possible costs which could be taken into account include void periods, says Peter Bastable, managing director of Simply Mortgages. "Student accommodation, for example, might be vacant during the summer months." Some investors take out life cover, which would clear off any outstanding mortgage in the event of their death. Opportunity costs are another issue, says Bastable. "With substantial entry costs and no prospect of making profits in the initial years, one could argue there are better ways to spend your money."

The chart provided calculates an investor's net financial loss at the end of the first year of purchase of a two-bed city centre apartment in Dublin, Cork and Galway. All are based on a 70 per cent mortgage at a standard variable rate of 6.64 per cent - rates for investors are generally a half a per cent above the norm.

The standard of fit-out of an apartment will depend on the type of tenant a landlord wants to attract. If they are aiming for a corporate market, then the cost could be as high as £10,000-£15,000. If skimping on the decor, it's possible to fit out for as little as £5,000. The £8,000 fit out estimation in the table is based on the average cost of furnishing an apartment aimed at a middle-income tenant. An annual maintenance fee of £1,500 is also taken into account, which allows for the service charge on the apartment and any internal repairs or work required over a period of a year. Both the fit-out and the maintenance costs are allowable as expenses.

The sums are based on a two-bed apartment, as the bulk of apartments built in Dublin over the last four years have been two-beds. The same applies in Cork and Galway. At the end of the first year, substantial losses are inevitable in all cases. In the second year, while the set-up costs no longer apply, there are still significant losses when the deficit between rental income and mortgage repayments and the tax liability on rent is taken into account.

Long term profit depends on capital appreciation which applies only if the property is sold, at which time a 20 per cent capital gains tax applies. Although the chart is based on two-bedroom apartments for uniformity, according to Johnny Lappin of Douglas Newman Good, investors in Dublin property tend, if possible, to go for one-bedroom apartments in prime locations which can command rents of £700 to £800. A two-bedroom apartment requires a bigger capital injection and may only command £900 to £1,000 per month rent.

Lappin reckons that as yields depend on the purchase price and the level of rental income achieved, it is still possible to recoup over a number of years. At the moment it is possible to buy a one-bedroom apartment for £128,000 in Christchurch which could fetch a rent of £600 a month; a one-bedroom converted flat in Upper Dominick Street in the north inner city is £107,000, and could command a rent of £600 a month.

Even at that, there is no denying that yields are low. Even those who purchase one of the few Section 23 second-hand apartments left with substantial tax allowances are no longer allowed to write off the interest payable on a mortgage. Following a proposal by Peter Bacon in his first report, the Government curtailed this incentive so that investors have relief on rental income only.

Joseph McCarthy of Irish and European in Cork says that 75 to 80 per cent of apartments in Cork are two-beds which can command rents pitched between £600-£650. He says that apartments originally built for the investor market are now being bought by young couples.

Paul McLoughlin, regional new homes manager for Sherry FitzGerald and Ross McParland in Galway says that Galway investors now have to face the fact that they will have to subsidise any purchase they make for a number of years. "Many of the investors here are now from the east coast.

Prices can be somewhat cheaper in Galway than Dublin and capital appreciation is not far behind Dublin in good locations." Rents in Galway are lower than in Dublin, however, with the average of £600 to £650 per month for a two-bedroom apartment.

One new option opening up for investors is the Section 50 tax incentive scheme described by the Government as "Section 23 type relief" aimed at improving the supply of rented student accommodation. Apartments and houses eligible under this designation must be let to students during the academic year for 10 years but can be let to tourists during the summer.

However, stamp duty levels and the lack of interest relief on borrowings means that investors are so far not investing in Section 50 in droves. And according to Alan Maxwell of Maxwell & Co in Galway, the Section 50 only applies in certain areas near colleges. "For the ordinary Joe Soap, it is prohibitive."

Donal Palmer of Palmer Auctioneers in Waterford says the residential investor market in Waterford is dead. "With stamp duty, people are looking outside Ireland to invest. Whether Section 50 is successful or not is debatable as students can be rough on an apartment, which can be a deterrent. Often after two years, you wouldn't recognise a property."

emorgan@irish-times.ie