Buy to Let: Yay or Nay?

The buy to let boom stretches back generations. The number of households owning buy to lets has tripled since 1980 and now more than 6% receive an income from investment properties (Thisismoney). Of course, young whippersnappers including those in our team at DB Wood are pushed to rent or stay at home for longer, simply because they can’t afford to buy.

Nearly everyone knows someone who has made an empire out of property investment, so the behavioural biases are strongly in favour of this type of investment. How do you argue with that person that it is better to invest in a diversified portfolio of assets, rather than what they know? Property is tangible, it’s real, it’s bricks and mortar, you are in control and people like that.

We cannot deny that there are further benefits to investing in buy to let properties. First of all, the yield (income as a percentage of the property’s value) is strong and has grown on average from 3.8% to 5.6% in the last six years alone (Thisismoney). It should be remembered however, that this assumes the property is constantly rented, and for most people the yield will be reduced by 20% or 40% income tax, not to mention the cost of keeping the property maintained. In reality, the natural net yield will range from 2% to 3%.

You do also have the potential to benefit from the capital growth though, which historically has been fantastic, provided the property has been held for the medium to long term. However, as you will read at the bottom of nearly everything our Investment Committee ever publish, “past performance is not a guide to the future”, and in our view residential property prices will not replicate the growth rates seen over the last 20 years (note point 3 below). Indeed, property prices in the UK excluding London have not grown at all over the last decade. As with everything, it is the price you pay for an asset that is important.

With property, one of the key things to be aware of is liquidity (the ease of changing something to cash), which is extremely poor. Let’s face it, you can’t say “I need £15,000 so I’m going to sell my ensuite”. Moreover, the net return you receive will also be dependent on your tax status as the profit you make on the sale will be subject to 18% or 28% capital gains tax.

We strongly believe in the benefits of diversification, so as part of a diversified portfolio, property can work extremely well, but all too often we see examples where investors have put too many of their eggs in the property basket. Inheritance tax is also worthy of consideration. Property is very difficult to ring fence from the 40% tax charge. Obviously property can be gifted, however, Her Majesty’s Revenue and Customs will still require a tax payment on disposal of the asset even if hard cash is not transferred.

At this point our technical team have hijacked this blog to talk about some of the recent changes to the taxation of income from buy to let properties, which are summarised below:

If holding only a small number of properties, these should be held in your own name (or jointly where appropriate) rather than a property company structure, as HMRC are unlikely to grant you the tax benefits and reliefs afforded to company structures where only a single or small portfolio of properties is held.
From 2020, interest payments will no longer be tax relievable i.e. they cannot be offset against rental income for higher rate taxpayers. If you are likely to remain a higher rate taxpayer throughout the period of ownership, a buy to let property is likely to no longer be a tax-efficient investment option.
Property prices in the UK allegedly rose circa 9% in the year to February 2016, though this is hugely weighted towards London, the rest of the South East, and the odd regional area. The national trend is very much of slow decline in year on year returns. We therefore expect property prices in the UK to flatten, particularly when the tax advantages diminish completely for higher rate taxpayers.
The March Budget emphasised the Government’s crack down on buy to let owners, introducing a reduced capital gains tax rate for everything except investment properties, and increases in Stamp Duty!

In summary, there is historic evidence that the buy to let market has produced exceptional returns. However, the landscape is changing so it is vital to be very careful what you acquire and be mindful of your current and potential future rates of tax. Our thoughts here have been very general, and it’s vital to remember that every situation is different, so please come and talk to us about anything specific to you.

References:

This is Money. (2016). Housing generation gap laid bare: number of households making money from property triples since 1980 – while young buyers are kept off the ladder. [Online]. Available at http://www.thisismoney.co.uk/money/buytolet/article-3526382/Buy-let-landlords-triple-1980-young-buyers-kept-ladder.html. [Accessed 07.04.2016].