Is Buy-to-Let still worth it?
Changes to mortgage interest relief, a surcharge on stamp duty for second homes and the continuing introduction of regulatory legislation (eg electrical inspections: EICR requirements) has made many landlords-to-be ask the question: ‘Is Buy-to-Let still worth it?’ Many landlords’ profits have taken a hit as a result of changes to tax laws. So should you give up on residential property – or is it still a useful source of income?
How has Buy-to-Let changed?
Property price growth has increased over the last 18 months, but then so have rents making buying to let less risky than it has been in the past. However, the government has clamped down on the buy-to-let market in recent years with changes to the tax system.
Firstly, in 2016, it added a 3% surcharge in stamp duty on additional properties, such as second homes and buy-to-let properties.
Secondly, since 2017, the government has been reducing mortgage interest relief. The previous scheme enabled landlords to deduct the interest they pay on their mortgage before paying tax. This effectively gave higher-rate taxpayers 40% tax relief on their mortgage payments.
This won’t have a negative impact on most landlords who were already basic-rate taxpayers, but will mostly affect those who are higher or top-rate taxpayers. However, one snag is that landlords will have to declare the income used to pay their mortgage on their tax return (under the old system, they could declare rental income after deducting mortgage repayments). This apparent income rise could push some up from the basic rate to the higher rate, which would mean a higher tax bill.
How have buy-to-let profits changed?
With mortgage interest relief no longer on offer, many landlords have seen their profits significantly reduce – in particular, higher rate taxpayers. They can no longer receive the full 40% tax relief on their mortgage payments, so their tax relief is effectively halved.
The new changes are particularly hard hitting for landlords with interest-only mortgages (which the majority are) paying higher tax rates. Here’s an example of how their tax has changed – it’s for a landlord paying £500 a month in mortgage interest and earning £1,000 a month in rent.
|Before 2017||From 2020|
|Annual rental income||£12,000||£12,000|
|Annual mortgage interest||£6,000||£6,000|
|Taxable annual income||£6,000||£12,000|
|Tax credit of mortgage interest||0% (£0)||+20% (+£1,200)|
|Tax bill (lower rate)||£1,200||£1,200|
|Tax bill (higher rate)||£2,400||£3,600|
Is buy-to-let still a worthwhile investment?
The answer to this question goes beyond the issue of tax. To a large extent it depends on the type of investment you’re looking for, and the ultimate goal of your investing activities (i.e. why do you need the money?). Here are some pros and cons of buy-to-let as a way to generate a return.
Advantages of buy-to-let
- You’ll earn rental income (likely to be greater than in previous years). In the Bury St Edmunds area rental yields on new build property in say Marham Park and Lark Grange can be in the region of 5% while more established rental properties typically yield 3-4%.
- At the same time, you could generate capital growth as your money grows with your property value increasing.
- You can reduce your risk by procuring landlord’s insurance to cover against loss of rental income, damage and legal costs.
Disadvantages of buy-to-let
- Your tax bill will be higher than it once was, eating into your profits.
- If you don’t have the right insurance in place, you might not generate an income if the property is unoccupied.
- If property prices fall, your capital will reduce. And if you have an interest-only mortgage, you’ll need to make up for any shortfall if the property sells for less than you bought it for.
- You’ll need to factor in the costs of stamp duty, insurance and wear & tear.
- Being a landlord is a big responsibility. Check out these tips before deciding.
- Lots of people choose buy-to-let as a retirement income, often taking tens of thousands of pounds out of their pension pot to do this. If you are looking into this possibility, it is vital you speak to a financial adviser first. Touching your pension pot can have big implications and potential tax penalties.
- How do I get started with buy-to-let?
- Your journey to becoming a landlord will typically involve five steps:
- Step 1 – Get your finances in order. Now is the time to speak to a financial adviser, to decide how much money you should be investing and the kind of returns you should be aiming for. Also speak to a mortgage broker to get the best deal (or mortgage in principle) so you’re ready to make offers when you find the right property.
- Step 2 – Find your property and get your offer accepted. This might be quicker than buying a home, if the property is already rental – but it might not be. Allow a good few months for the process.
- Step 3 – Take out landlords’ insurance. Along with buildings insurance, you’ll want to protect against unexpected costs like injuries to tenants, damage and loss of rent.
- Step 4 – Find tenants. You can go through an agency or find your tenants privately. The right option for you depends on how involved you want to be. But remember: even if you hand-pick your own tenants and already know them well, draw up a legally binding contract. Friendships have ended over far less than a flat!
- Step 5 – Buy-to-let is a hands-on investment. You’ll need to keep reviewing your mortgage when your current deal expires, and conduct any necessary maintenance on the property. You should also make sure that your income from buy-to-let is handled in the most tax-efficient way – an accountant can help you do this.
- Check out a useful guide to buying to let.
· What are some good alternatives to buy-to-let?
- As an investment buy-to-let has much to offer: a regular source of income, plus a potential long-term yield from any increase in the property’s value. Against that, it is a high-maintenance investment, and your asset is locked away for a long time and hard to get at (i.e. it’s not ‘liquid’).
- So depending on your investment goals, it’s worth considering whether any of the alternatives suit you better.
Real-estate investment funds
- If you want to invest in the property market without fixing a boiler every other winter, then real estate investment funds might be an option. You can pool your funds with others and invest in commercial properties, which can all be done through investment companies trading in public markets. Average return over recent years has been 10%, but these are long-term investments that generally involve locking money away for several years. That said, it is a more liquid form of investment than directly owning a property.
- Bonds are a relatively stable, low-risk form of investment – though some are more risky than others. Bonds are essentially loans made by the investor to a borrower (often a government or large organisation) and are repaid over a set period of time at a fixed rate of interest.
- As well as government bonds (gilts), large companies across the UK offer these investments with returns usually around the 5% mark. You can choose different length bonds, keeping your money tied up for just one year or up to ten years.
- Various platforms allow you to offer loans directly to small businesses and individuals. By cutting out the middleman, peer-to-peer (P2P) lending tends to generate higher returns than cash savings or bonds can. The downside is that the risks are higher than either, and your money isn’t protect by the Financial Services Compensation Scheme. But this can be a good platform for the investor who wants to take a bit more risk for the sake of higher potential returns. And of course, you can invest smaller sums than you would in a property.
- Shares are considered high risk investments, which means they are volatile and likely to fall in value during some periods, and rise in others. The typical return from shares over the longer term is between 8 and 10%, so for the patient investor they can be very rewarding. Your money also isn’t tied up for as long as it is with property. But be prepared for a bumpy ride, and don’t invest money you might need over the next few years.
The truth is that it is prudent to have a mixed portfolio with a selection of investment vehicles to spread the risk and Buy-to-Let undoubtedly continues to provide sound investment opportunities. Initial correct property selection is crucial and continuing close management essential, whether by the investor or managing agent.
Based on article by Nick Green, writing for Unbiased.co.uk