Doom & Gloom for the Property Tycoon

Article by Phil Mason

(This article uses HMRC legislation for Buy-to-Let landlords in England, which also applies to Northern Ireland. Different taxation applies to Wales and Scotland).

As the old saying goes, an Englishman’s home is his castle. But in more modern times, many Englishmen (and women) have more than one castle. I often get questions from Clients about investment opportunities in buy-to-let property, usually with pound signs in their eyes and chomping at the bit having heard tales that being a landlord is a long-term easy and steady investment with good constant returns.

This article is not to say that buy-to-let property investment is good or bad, right or wrong (that will all depend on individual circumstances), however, it is designed to give you a bit more of an insight into the buy-to-let world from an investment perspective and hopefully explain why it is arguably not always the easy investment opportunity that some believe it to me. This article is aimed at the accidental/casual landlord i.e. those that become landlords by accident such as inheriting a property and renting it out or landlords that own one or a couple of buy to let properties, compared to professional or institutional landlords that are typically investment funds or banks etc that own hundreds of properties.

Many clients I speak to only look at the headline rates: buy a property for £200,000, charge £1,000 per month for rent and that’s a 6% annual return on their investment, plus a potential increase in value of the property, happy days! However, the reality is quite different when factoring in the running costs, taxes and work involved, the returns then turn out not to be so attractive.

Before we get to that, I’ll start by looking at the buy-to-let landscape and the changes the Government have implemented, and are implementing, that make it harder for landlords to get returns on their investment.

Since 2015, landlords have been the subject of punitive policy changes, especially since April 2016 when the additional Stamp Duty Land Tax (SDLT) surcharge hit buy to let property purchases. Anyone purchasing a second property will now get this with an additional 3% SDLT for the first £125,000 and 5% instead of 2% on the portion between £125,001 and £250,000 and 8% on the amount above £250,001.*

In addition to this, there were changes to mortgage tax allowance the following year that dealt a further blow to investors’ confidence.  On 1st April 2017, the income tax relief that landlords can claim on residential property costs was reduced and by April 2020, landlords will not be able to deduct any of their mortgage expenses from rental income to reduce their tax liability. This has been replaced with a tax-credit, based on 20% of the mortgage interest payments. This penalises higher-rate taxpayers, who effectively received 40% tax relief on mortgage payments under the old rules.

The self-assessment tax deadline for the 2017/18 tax year was the first time many landlords experienced the impact on profits from the changes to mortgage interest tax allowance.

One question clients ask me is whether they should set up a limited company and transfer their properties into it, believing it to be more tax efficient. Whilst it can be a better way of holding a property portfolio for new investors entering the world of buy to lets, for existing landlords transferring their properties into a limited company can actually be extremely detrimental. Firstly, the property has to be sold and then bought by the limited company, both at market value, which can result in capital gains tax on selling the property, and then the company will have to pay the additional stamp duty again. On top of this, if the property needs to be mortgaged, the company would likely require a commercial mortgage, which generally carry higher rates than residential mortgages.

The final kick in the shins to this plan is that if and when you eventually want/need to sell the property, the proceeds are paid into the limited company, which results in 19% corporation tax on the profits. The residual funds then need to be paid out either as a salary or dividends which results in further taxation as income – OUCH!

Research shows that the pre-tax cost of running a property is increasing by an average of 5.6% in the last two years, this effectively means less profit. To offset this, many landlords are trying to reduce their overheads where possible, while others expect to increase rents, which can increase the risk of having a vacant property if rent becomes too expensive when compared to other properties in the area, further reducing profits.

In addition to the policy changes and rising costs, there is also a risk of further regulatory changes lurking in the background. The Mayor of London has been looking into the prospect of rent control – effectively dictating rent prices and preventing landlords from making a profit, thus potentially resulting in a reduction in the standard of rented accommodation or the amount of rented accommodation available if London landlords exit the market.

Nowadays, being a (proper) landlord tends to be a full-time job and needs to be as a business, requiring ongoing investment in time and money. This involves sourcing tenants, providing them with a continuous service (effectively customer service), and ensuring the quality of rental accommodation is suitable for the local market and sufficient to maintain the property’s value.

Alternatively, many landlords outsource, but this comes at a price that obviously reduces profits even further. A survey conducted by BVA BDRC shows 55% of landlords surveyed saw profits reduced since the changes to the mortgage tax allowance and stamp duty surcharge were announced.

For landlords with mortgaged properties, otherwise known as gearing, the impact has been far greater with 75% of mortgaged properties profits reducing, compared to just 25% of those without gearing.

This article is not to say getting a buy to let property is a good or bad investment with ever decreasing returns, it’s just even more important for landlords and prospective investors to understand the full range of costs involved in servicing the average rental property, how costs have changed in recent years and where they may be able to make savings.

The pre-tax cost of running a rental property has increased in recent years. Excluding mortgage costs

landlords now spend £3,571 per year, up 5.6% from £3,382 two years ago.2 This represents 33% of a

landlord’s gross rental income, slightly up from 32% in 2017 as costs have risen slightly faster than rents. Over the past decade, average pre-tax costs per year have risen by £771, up 28%.*
The pre-tax annual cost of running the average rental property (excluding mortgage costs) can be seen below

According to Zoopla, a gross rental yield of 7% is required to make buy to let a worthwhile investment. But once you factor in all of the running costs, mortgage costs and the impact of income tax on the rental income, many landlords are struggling to get a net return above 1%, which is quite a small return given the amount of stress and hassle that can be associated with being a landlord.

All that said, there are many benefits to using property as a means of investment, and as with other investments risk, cost and liquidity are all considerations which would benefit from good professional advice. 

If you feel that the UK property market is a good investment opportunity but don’t want to be a landlord, there are other options available.

Are you considering using property as an investment towards your long-term financial goals? Then speak with your Prosperity Advisor or call 01329 821950 to book a free initial consultation.

*= All figures and statistics in this paragraph were provided by Kent Reliance.
SDLT correct for 19/20 tax year as per HMRC website