Over 20 years, the average UK house price has outpaced inflation by around 3% a year. And in some regions, it will be much higher. Little wonder, then, that so many are drawn to buy-to-let investing. That is attractive capital growth before you even consider rental income.
Historically, many investors saw property as an easy way to make money. With 95-100% mortgages commonly available, and a benevolent tax regime, they could effectively gear their investments.
They laid down a relatively modest deposit, wrote off mortgage interest against tax and watched rental income more than cover the bills – all while riding the wave of a fast-rising market.
Browsing through TV channels or on social media, you might think we can’t get enough of property. Whether it’s property ‘flipping’, renovations or grand designs, there seems to be as much enthusiasm for it as ever.
But is buy-to-let still a good investment? To anyone asking if they should invest in property now, we have three questions:
- Are you prepared for the hassle?
- Do you have the time and expertise to manage a project?
- And do you understand how the risks have changed?
Trouble and strife
The point of financial planning is to help you achieve your objectives in life. Money is important to that, but it should be a servant to your needs. If you are in your late 50s and heading for a retirement focused on the garden, travel or grandchildren, or if you are a business owner working flat out, do you have time for the hassle of managing a property?
Even if you are blessed with that rare commodity, an outstanding letting agent, can you be bothered with sorting a plumber when the boiler breaks on Christmas Eve? Do you fancy taking calls about the electrics while you’re lying on a beach?
The more people who live in your property – think students and houses of multiple occupancy (HMOs) – the more renovations and maintenance you’ll have to do. For HMOs, work usually takes place in the summer when the property is empty. But also when you might prefer to be on holiday.
Just as a rising tide floats many boats, a rising market has allowed many property investors to feel they are experts. When you buy a property to sell on, genuine expertise and the ability to manage a project from start to finish is essential if you want to make a meaningful profit. Particularly as the cost of labour and materials has increased so much in recent years.
It is no longer possible to simply buy a property, put in a new kitchen and bathroom and sell it for an inflated price. It requires careful planning, full-on project management and the ability to keep to a budget. Does that sound a bit like a job?
If you have expertise in the building, electrical or plumbing trades, and are prepared to commit that time, perhaps that could work for you. Otherwise, you will be reliant on tradespeople who could well earn more out of the project than you.
Buy-to-let investing: Considerations and risk
When considering an investment, you must understand and factor all requisite costs – agencies, insurance and maintenance – into your calculations. If borrowing money, you must be honest with your lender that this is for buy-to-let. The loan terms will be higher than for a normal mortgage. Also, remember you will usually pay tax on the money you make.
In recent years the government has introduced a number of changes that have financial implications. There is now a 3% higher rate of stamp duty on acquisition, and landlords pay an extra 8% in capital gains tax on disposal. Other changes include the scrapping of ‘wear and tear’ allowance – a 10% income tax relief you could claim to help cover maintenance costs.
Tighter regulations on HMOs add to the tenant burden, and there have been reductions in the fees you can charge. Then there is mortgage interest relief. Previously you could write off mortgage interest against your profits before paying tax, benefitting higher-rate and additional-rate taxpayers. Now you are given a flat-rate tax credit based on 20% of your mortgage interest.
You must declare the income used to pay the mortgage on your tax return. While previously, you declared it after deducting mortgage payments – this could push you into a higher tax bracket.
All of those extra costs mean a property investment has to work much harder these days to make a profit for you. Your tradespeople, suppliers, the bank and HMRC will all get paid before you do.
There are also a number of financial risks to factor in. The first is that you might not get the rent you expect. Many landlords have found this during the pandemic. We know several clients who were very patient and generous in these circumstances. But if tenants persistently default without reason, it can take time to remove and replace them.
Many landlords have had to reduce the rent they charge, even to new tenants. We have heard of one client who was not receiving rental income because the agent was withholding it. They started county court action and lost several months’ rent before the agency went bust.
Interest rates pose another serious risk for those borrowing to buy. They have been historically low for many years but could easily increase. Use an outline calculator and stress-test your plan to see how the books would balance if interest rates doubled or even multiplied five times. Also, consider what rising mortgage costs might do to house prices.
Lots of people say ‘there’s always money in bricks’, and it is true that house prices have risen sharply, but there have also been periods when they have fallen. Between June 2007 and February 2009 they fell by more than 25%, for instance. In fact, the returns on property can often be similar to a middle-of-the-road investment in a mixture of equities and bonds. Don’t just assume house prices will continue to rise.
Something else to consider is what happens if your personal circumstances change. How soon might you need the money invested in a property if you or your partner were to lose a job or become ill? We all know houses can take months to sell.
Some people investigate buy-to-let investing using their pension tax-free lump sums. If you do that, you are taking money out of inheritance tax-, income tax- and capital gains tax-free environment, so there has to be quite a compelling property proposition to make that stack up, and it can backfire quickly.
We would urge you to think very carefully and critically if this is something you are considering.
Buy-to-let investing remains a viable option for many. But it works best when it is part of a balanced, diversified investment mix and ideally where you can add something special to the mix – trades or design skills, for example.
It should only be entered into when you have thought through all the costs – personal and financial – and considered the risks and the alternatives.
If you have any questions about buy-to-let investing or want to discuss your financial plan, please feel free to get in touch with us any time to have a chat with one of our independent financial advisers.
A version of this piece first appeared in What Investment.