With savers receiving poor returns from banks and building societies, thousands of people unsurprisingly continue to turn to residential property as a means of supplementing their income, supported by high demand from tenants and stable yields, as buy-to-let remains the investment of choice.
Despite a challenging few years for the buy-to-let market, characterised by tax and regulatory changes, and for some, higher mortgage mortgage borrowing costs, investment in buy-to-let continues to outperform most major asset classes, as rents continue to rise. Around a sixth of the population – some 10 million people – now living in accommodation rented from private landlords; an attractive proposition for those investing the buy-to-let sector.
“The private rented sector is vital to our economy and without it would see a huge increase in homelessness,” said Allison Thompson, MD of lettings at Leaders Romans Group (LRG).
Earlier this month, LRG surveyed 271 landlords across its country-wide estate agency brands, from those with a single investment property (46% of the sample) to those with ten or more (4%). It found that only 7% of landlords plan to exit the BTL market in the next year and 12% plan to reduce their portfolio. In contrast, a considerable majority (71%) planned to maintain their portfolio size and 10% planned to expand it.
Of the 51 landlords planning to sell, the most common factor which impacted on decision-making, at 41%, was changes in policies: both increased regulations to date such as regulations regarding increased compliance and safety such as Smoke and CO detector requirements; also the imminent Renters Reform Bill and other emerging policies. Landlords responded equally (29%) to the two other reasons offered: the economy (interest rates, energy costs, lack of disposable income) and personal circumstances unrelated to income.
Thompson commented: “It is very good news that 81% of our landlords still see residential property as the best form of investment and plan to maintain or increase their portfolios over the next year. A property investment is for the long term. It is one which will see many economic cycles and changes of Government, but despite interest rates rising and falling and regulations coming and going, a BTL investment will invariably deliver a good financial return. However, the government must realise that the housing crisis – specifically the under-supply of rental units – cannot be resolved by penalising the already stretched private rented sector (PRS). It is vital that the Government re-considers the components of the proposed legislation which are putting off some landlords.
This includes the much-talked about proposals to require rented properties to have an EPC rating of C, and also proposals surrounding Section 21 and assured shorthold tenancies (ASTs). It has been suggested that tenants might be permitted to serve notice of two just months at any point. This would create considerable uncertainty for landlords, which is unwelcome in an already challenging market. There has been a request to amend this, so that two months’ notice is only permissible when the tenant had been in the property for at least four months. This compromise would provide some further security for landlords, while allowing flexibility for tenants.”
Buy-to-let Tips
1. How much deposit do I need for a buy-to-let mortgage?
While a standard mortgage can be secured with a deposit as little as 5% of the property price, the minimum deposit for a buy-to-let mortgage is usually 25%.
You typically also need to earn at least £25,000 a year.
2. Buy-to-let mortgage rates
Some of the fees and the interest rates for buy-to-let mortgages can be higher than for a standard mortgage.
Also bear in mind that most buy-to-let mortgages are not regulated by the Financial Conduct Authority (FCA). Such mortgages are usually offered as interest only. This means your monthly payments will be lower than for a repayment mortgage but you aren’t actually reducing the debt. On the plus side, these mortgages often give you the flexibility to pay off part of your loan each year when your rentals are more profitable. Check first for penalty fees, especially if you have a fixed rate.
You could sell the property to repay the mortgage. But if house prices fall and the proceeds don’t cover the outstanding debt, you could be in negative equity and may have to make up the difference yourself. So it’s worth building up a financial cushion to make sure your property empire doesn’t come tumbling down.
3. What are the disadvantages of buy-to-let?
The lustre of buy-to-let has faded significantly in recent years. A variety of government measures has made property a less attractive investment than it used to be. Many landlords have decided to drop out and sell up, as new fees and the loss of tax relief have narrowed profit margins (more on that in a minute).
Being a buy-to-let landlord means you will likely have to:
- Apply for a buy-to-let mortgage to purchase the property, which is much pricier than a residential mortgage
- Respond to calls about a flooded bathroom
- Deal with the occasional nightmare tenant
- Finding tenants pay an agency to do so
Investing in buy-to-let can carry significant risks and is only suitable for people who have a financial cushion to soak up unforeseen costs. Managing a property can also take up a lot of time, and should not be seen as a short-term investment.
4. Buy-to-let tax rules
In April 2016, the government imposed a 3% stamp duty surcharge on second homes and buy to let properties in England, Wales and Northern Ireland. Landlords still have to pay the 3% surcharge on the whole property. So if you buy a rental flat worth £400,000, the 3% stamp duty surcharge works out as an extra £12,000.
The surcharge is on top of the usual stamp duty rates, which we outline here. In Scotland, second home owners and buy-to-let landlords have to pay an extra 4% in stamp duty. Buy-to-let investors have also been hit with more tax changes.
Until April 2020, private landlords could deduct mortgage interest payments from their rental income when calculating their tax liability – known as mortgage interest tax relief. However, since buy-to-let landlords now have to pay income tax on the ENTIRE rental income, regardless of how much is swallowed by mortgage interest. Landlords can take advantage of a new 20% tax credit on the interest. This makes the change neutral for most of those in the basic tax bracket (some will lose out though by being pushed into the higher tax bracket because of the new way tax is calculated).
However, landlords who pay income tax at 40% or 45% will be paying far more than before the shake-up.
Calculating buy-to-let tax
Let us assume monthly rental income of £1,000 and mortgage interest payments of £400. We’re ignoring other expenses that can be set against tax.
- Annual rental income = £12,000
- Annual interest paid = £4,800
Tax on annual rental income:
- If you pay tax at 20% = £2,400
- If you pay tax at 40% = £4,800
- Tax credit on interest (20% of £4,800) = £960
The tax bill you’ll have to pay:
- Basic-rate taxpayer: £2,400 – £960 = £1,440
- Higher-rate taxpayer: £4,800 – £960 = £3,840
- Under the previous tax rules before April 2020, both owners could deduct their interest payments from the rental income before calculating their tax: £12,000-£4,800 = £7,200.
The lower-rate taxpayer had to stump up the same as under the new system — £1,440.
But the higher-rate payer paid nearly £1,000 less — £2,880 — so they are the ones who have really been hit by this new system.
These figures need to be declared on a tax return.
5. How to cut buy-to-let costs
If you don’t fancy paying so much extra tax on your rental income, you could think about purchasing a buy-to-let property through a limited company. The sums don’t add up for everyone so you would need to take expert advice before making such a leap.
If the property is owned by a company, all costs, including mortgage interest payments, can be deducted as business expenses. The company pays corporation tax on profits. The tax rate is currently set at 19%.
As a landlord, you can draw income in the form of dividends.
In the 2022/23 tax year, the first £2,000 of dividends are tax-free. But you pay tax on further withdrawals at:
- 8.75% as a basic-rate taxpayer
- 33.75% if you fall into the higher-rate bracket
- 39.35% for additional-rate taxpayers
- Capital gains is also a consideration as the company will be liable for corporation tax on gains if a property is sold at a profit. Then you’ll pay income tax if you need to withdraw the money.
One advantage of a company is that you only have to take out the money at a time that suits you. This could be in a tax year when other income is low because, say, you take a sabbatical.
6. Do first-time buyers qualify?
In theory, it is possible for first-time buyers to get a buy-to-let mortgage. But in reality it can be difficult as lenders often consider this group too risky. The number of mortgages on offer to you will be more limited so you will likely need a bigger deposit to get a good deal.
The lender will look carefully at your circumstances and reasons why you want to purchase a buy-to-let property without having owned your own home.
7. Not all properties are profitable
You need to demonstrate that renting out the property will be profitable in order to secure a buy-to-let mortgage.
How to calculate rental yields:
- Take the yearly rental income of a property
- Divide this by the amount you paid for the property
- Multiply the figure by 100 to get the percentage
Don’t forget maintenance and insurance costs, any managing agent fees, mortgage interest, plus periods in which the property might sit empty. All these costs will eat into the rental yield.
You will also need to show you can still pay the mortgage if interest rates rise.
If you’re a basic-rate taxpayer, the rent has to be 125% of the interest, calculated at a rate of around 5.5%. This rises to 145% for those in the higher tax brackets.
A buy-to-let is also subject to capital gains tax if you sell the property.
This is charged at a rate of:
- 28% for higher-rate taxpayers
- 18% for basic-rate taxpayers
- The gain will be added to your income if you’re a basic rate taxpayer, so this could push you into to higher-rate band.
8. Should I cash in my pension?
If you are thinking about cashing in your pension pot to acquire a buy-to-let property, be careful.
Only the first 25% of your pension will be tax-free if you withdraw it, the rest will be subject to income tax.
You will have to pay:
- Stamp duty on the property you buy
- Tax on your rental income
- And eventually capital gains tax if you sell
If you leave the house to your loved ones when you die, the property will be subject to inheritance tax. Your pension isn’t normally liable for inheritance tax.
9. Know the area
It might be tempting to snap up a bargain two-bed flat in the north-east when you live in the more expensive south, for example. But be careful: not being familiar with the area can lead to serious losses.
The demand for rentals in the area could be weak or falling, and the ban on most letting fees for tenants may mean estate agents have fled the scene, so you could find it difficult to let the property.
Should you decide to sell the property, you may find yourself taking a hit. So do your research and also consider the type of prospective tenants in the area: is there likely to be demand from young professionals, young families or students?
That will also dictate the type of buy to let property you purchase.