Buy-to-let property has become one of the hottest areas for investors, but would-be landlords need to think carefully before taking the plunge.
The Bank of England says that the number of buy-to-let mortgages has risen by 40% compared to a rise of just 2% of lending to the owner-occupied sector. That has pushed the share of buy-to-let lending to 16% of the total, up from just 12% in 2008.
Among the attractions are record low interest rates, which not only make borrowing to buy property cheaper, they also reduce the income available from alternatives like keeping cash on deposit or buying gilts. Property prices in some areas of the UK have been rising strongly, generating capital gains for owners, while demand from tenants in some areas is also healthy, pushing up rents. Buy-to-let can seem like a one-way bet.
Diversify your assets
But these conditions may not last forever. Buy-to-let investors should be aware that the market can change quickly, leaving what seems like a safe bet looking rather less secure. The key is to avoid relying too heavily on any one type of investment and to view rental property as part of a diversified portfolio of different types of assets. If rental property goes through a difficult patch, other parts of the portfolio may be earning sufficient returns to cushion against that underperformance.
Illiquid and taxable
Investors should also be aware that property is an illiquid asset: selling can take time, particularly if the market turns and others are also anxious to make an exit.
Also, unlike owner-occupied homes, buy-to-let sales are subject to capital gains tax on any profits made.
In certain circumstances the administration and other costs of buy-to-let can be high. Purchases above £125,000 are subject to stamp duty of between 2% and 12%, depending on the cost of the property. Ongoing costs include advertising and agency fees for finding a tenant, repairs and maintenance, gas and other safety inspection certificates, insurance and tax on rental income. Even a month or two without a tenant can quickly erode returns – and rents can fall as well as rise.
Tax changes looming
A report published by the Council of Mortgage Lenders in September indicated the buy-to-let sector could face more serious challenges. It said: “Although there are many socio-economic factors supporting further strong growth in the private rented sector, the medium- to longer-term prospects for buy-to-let have suddenly become less certain. They are likely to be affected by the tax changes announced by the chancellor in his summer Budget, as well as regulatory developments.”
It is only now becoming clear how damaging these tax changes could be for some landlords. The most drastic reform will restrict tax relief on mortgage interest to the basic rate of 20%.
Higher-rate taxpayers who own buy-to-let properties on which there is a large mortgage will be worst hit. The restrictions that will be phased in over the course of four years, starting in 2017, could wipe out at least half of landlords’ profits, according to some estimates. Some will find their buy-to-let business is no longer financially viable as they will suffer a cash loss after tax.
Even some basic-rate taxpayers will be worse off. The changes will push some into the higher-rate tax bracket landing them with bigger bills.
The existing “wear and tear” allowance, which lets landlords reduce the tax they pay regardless of whether they replace furnishings in their property, will also be replaced next April by a system where they only get tax relief if they do replace furnishings.
The reductions in these tax reliefs are a particular blow given that investors cannot use tax shelters such as ISAs and pensions to reduce their income and capital gains tax liabilities on buy-to-let property.
Who’d be a buy-to-let landlord?
Prospective landlords should weigh up all the pros and cons before committing their money to bricks and mortar.
Generally, a diversified portfolio is a better way to protect your assets against adverse conditions. Spreading the risk across different asset classes, regions and sectors helps protect investments against large movements in the market, whilst diversification also helps to achieve smoother, more consistent investment returns over the longer term.
For investors, that means a balanced portfolio including equities, bonds and cash as well as some property – residential or commercial – if appropriate.
A recent report by specialist buy-to-let business Platinum Property Partners indicated that nearly one in eight landlords fail to consider any costs when calculating the profitability of their property portfolio and may be overestimating returns by up to 50%. Costs include letting agent fees (£438), maintenance fees (£506), repairs (£376), service charges (£500) and mortgage interest (£1,343).
Other costs that prospective landlords should consider include:
• stamp duty at 2% on properties costing between £125,000 and £250,000, and 5% on properties from £250,001 to £925,000
• Buildings insurance
• Void periods when the property has no tenant
• Arrears and damage caused by difficult tenants
• House price falls
• Rise in mortgage interest rates and re-mortgaging costs
• Capital gains tax on selling the property.
Time and energy
Finally, prospective landlords should not underestimate the time and energy needed to run a buy-to-let property. If you are raising a family, still working full time or entering retirement, you need to consider whether you can cope with handling desperate calls from tenants whose central heating has broken down, or whose plumbing is leaking.
Please post your comments and thoughts below