Buy-to-let properties have been a popular investment option for those looking to secure a useful income stream into the future, and perhaps into retirement. And, with interest rates at historic lows, it makes financial sense. But the rules are changing, and so has its appeal. We run through a typical scenario to explore the issues.
Property has long been considered a safe and sensible option for those with a lump sum to invest. The recent pension freedom legislation (April 2015) came at a time of an historically low run of interest rates, which has depressed returns on cash and pension incomes. Perhaps unsurprisingly, it only added to an upsurge of interest in buy-to-let investing. Since then, however, buy-to-let has been targeted by the government tax increases and also by the Bank of England, which has restricted lending to landlords with multiple properties.
So, where do we stand? To understand the attraction of buy-to-let, let’s go back to August 2016, when interest rates were at rock bottom, 0.25%, making borrowing unusually cheap, and therefore the buy-to-let business model unusually attractive. Let’s assume a two bedroom flat with easy access to a railway station for the London commuter, costing £275,000. According to a local estate agent, a rent of £995/month was realistic. Therefore, the yield can be calculated thus: rental income of £995 x 12months = £11,940, divided by £275,000 = 4.3%.
However, that is the gross yield, before costs, such as stamp duty. For a buy-to-let property, the stamp duty is £12,000 (£3,750 for a main residence). For legal costs, let’s assume a cheap £500, and another £500 in furnishings, bringing the total cost of the property at £288,000. Which brings the yield down to 4.14%.
Then comes the question of finding a tenant. More often than not, the rental income on which your calculations were based turns out to be optimistic. After months of the property remaining empty, you are forced to accept a rent of £950/month. Being a flat, you have to pay a monthly maintenance charge of perhaps £75, leaving you with a rental income of £875/month. This is now £10,500, or 3.64% yield.
This, after four months of the property being vacant, leaving you without income but still covering the council tax and maintenance charges. And perhaps you are also paying a 10% commission to the estate agent to manage the property for you, as you don’t live nearby. This means we now have a rental income of £780/month, less the 10% charge = £9,360.00, so a yield of 3.25% from 2017 onwards. Also to be factored in are other costs, such as the building’s insurance, insurance against tenants, costs for an accountant, bank charges, your personal time, etc. These factors can’t be included in this exercise as they can vary too much from case to case.
And, of course, not forgetting HMRC: the rent you receive is regarded as income and therefore taxed under income tax. If this is your only income, it would fall into your personal allowance and no income tax is due. However, if you receive other sources of revenue taxed at 20%, your monthly rental income will decrease to £624.00 (bringing net yield to 2.60%); and if your tax rate is of 40%, the same £780.00 becomes £468.00, a net yield 1.95%.
At this point, many will have decided that buy-to-let is not worth the extra stress. Other, more determined types may still pin their hopes on the potential for capital growth. In this case, another option presents itself: buy a bigger primary residence. The huge added benefits of this option is that you avoid buy-to-let costs (stamp duty, capital gains tax, estate agent’s fees, maintenance fees, etc) and the stress that comes with managing property.
If you get a mortgage, you use less of your savings in purchasing the house and you use the bank’s money to leverage your investment, therefore increasing the yield. So, a purchase price of £288,000, a deposit of £68,750 deposit (25% of house value), plus costs of £13,000 = £81,750 investment. A mortgage of £206,250.00 and an interest only rate of (a very competitive) 2.14%, gives £368.00 per month in interest repayments to pay. Of course, mortgage rates can go up as well as down, but they have to be paid with or without a tenant in place.
So, now we have an income of £780.00 less £368.00 = £412/month. This figure is much less but you only have £81,750 invested, so the yield becomes 6.04%. The increased yield is down to the power of leverage (ie. borrowing at cheaper rates from the bank).
You pay off the interest-only mortgage of £206,250.00, leaving £96,250.00. From this you take away your original capital of £81,750 giving a return of £14,500. Through leverage, your percentage gain isn’t 10%, but 17.7%. When the government introduced the stamp duty surcharge for second homes, they also introduced another tax change for property investors: from April 2017, anyone who is a 40% or 45% tax payer will no longer be able to offset all of the interest paid to the mortgage company against the property income. The new rule is being phased in over four years from April 2017, so that from April 2020 tax relief can only be claimed at the basic rate.
From April 2020, even though with the above case you have only received £412.00 income, you will only be able to offset 50% of the mortgage interest, so your income will be £412.00 but you will be taxed as if it were £596. Taxed at 40%, this is £238.40, so the net income is £412.00 less the £238.40, giving a net figure of £173.60 (57.8% tax charge). Over 12 months, that makes a total net income of £2,083.20, which is a net yield of 2.54%.
Taxed at 45%, that £596.00 is £268.20. The net income is £412.00 less the £268.20, giving a net figure of £143.80 (65.09% tax charge). Over 12 months that makes a total net income of £1,725.60, which is a net yield of 2.11%.
Remember all of this is when interest rates were at the best possible level (0.25%) for the ambitious multi-property landlord. Ten years ago (February 2008), just as the global financial crisis was about to explode, interest rates stood at 5.25%, before being cut right back to 1.0% one year later. Now, investors need to remember that with interest rates at historic lows, the only way is back up again. Already, the Bank of England among others have admitted that the UK economy is more robust than forecast last year, increasing the likelihood of another rate rise later this year. And, with banks restricting their lending to multi-property owners, the case for buy-to-let looks ever weaker.
What makes a good multi-property landlord
Making money from property isn’t as easy as it might seem, particularly when you take in to account the costs, the taxes and the rising interest rates, as well as the time commitment involved. But some still feel the buy-to-let business is right for them. Those most likely to make a success of being a multi-property landlord will likely be:
If you can tick these boxes, then being a multi-property landlord is an option for you. Just remember it’s not as simple as ‘I will buy the property for £275,000.00 and will receive £995.00 per month’. Otherwise, ask your financial adviser about other options, such as a portfolio of investment funds.