Dark clouds over buy- to- let investments
If you were thinking of investing in a buy-to-let property in the UK, in the last few years and were my client, I probably talked you of it nine times out of ten by sharing what I viewed as dark clouds over buy-to-let investments. Now, I cannot predict what property prices will do over time. No crystal ball here. My approach is to encourage clients to hear me with an open mind, then make their own decision. I elaborate on these views below. In case you haven't guessed by now, I am not a fan of buy-to-let property. Never have been. Although, I see why it is appealing to many. People know property in their gut; they have seen their parents and grandparents get great returns from property; it is often a decision that comes from this strong internal conviction. I get that. Also, you can create more wealth by borrowing or leveraging your gain with 25% equity in the property and a mortgage on the rest. I get that too.
Here are my reasons why I detest (hate is a strong word but I was tempted to use hate) buy-to-let property as an investment for income if you are a taxpayer.
1 . Dark clouds - tax
If you are a UK taxpayer, rental income is taxed like earned income. By creating more income, you are not really in control of the (tax) leakage. Here, think of a water pipe flowing towards you albeit with a hole. I am not against paying taxes; however, I am all for smarter ways of putting your money to work.
Proposals (dark clouds) were made to restrict mortgage interest relief on buy-to-lets to just basic rate, which were announced in the Summer Budget, 2015. Landlords will have a reduced ability to deduct the cost of their mortgage interest from their rental income when they calculate a profit on which to pay tax.
What does this actually mean? Scroll to the bottom of this blog to see a worked example which illustrates this point, assuming you pay 40 percent tax.
2 . Higher stamp duty
Come the Autumn budget, 2015 there was a double blow for buy to let owners. The first piece of bad news was the introduction of an increased rate of Stamp Duty Land Tax (SDLT) payable on the purchase of second properties worth more £40,000 from April 2016. An additional 3% will be payable on top of the standard SDLT residential rates.
And in moves to bring tax reporting in to the digital age, CGT payable on second homes will need to be paid within 30 days of a disposal from April 2019. This could bring forward the payment of tax by almost 22 months for some sales. So, more dark clouds.
3 . Diversification
If you have a UK residential property, your wealth pie has a large chunk of the UK property market. Why buy more slices of the same pie? The concept of diversification implies that you create a portfolio that includes multiple investments in order to reduce risk. Logic would therefore state that you would invest in other asset classes - bonds, equities or stocks, commercial property, etc.
4 . Other tax efficient ways to invest - ISA's and Pensions
Savers ideally could make the most of allowances by investing in both ISA's and pensions. For this tax year ending April 2016, it is £15,240 for ISAs and £40,000 for most pension savers. Pensions also have the additional benefit of effectively increasing the basic rate tax band.
Capital gains is tax payable on gains made via other investments such as investing in mutual funds. It is much kinder to your pockets, payable at a lower rate than income tax. Plus you can use ISA allowances, etc to wrap these investments and preserve tax efficiency.
It is clear that the property investment market is changing and more changes in the future are likely on their way. Britain has a high proportion of privately rented homes owned by individuals and the perception is that investors have been crowding out owner-occupiers. Property prices usually rise over time with inflation- in the last few years, however, we have had an unusual scenario of cheap borrowing and much financial support with schemes for new buyers to get on the housing ladder; London property prices have gone up sharply and I would tend to use the word bubble. Having said that, bubbles can stay bubbles for a long time.
UK house prices are at a fairly high point too - check out this link to the Economist which explains it visually and easily with hard data. Besides, other changes to mortgage interest (upwards) are likely to be on the horizon.
5. An example to hammer the point home
NOW
Your buy-to-let earns £20,000 a year and the interest-only mortgage costs £13,000 a year. Tax is due on the difference or profit. So you pay tax on £7,000, meaning £2,800 for HMRC and £4,200 for you.
2020
Tax is now due on your full rental income of £20,000, less a tax credit equivalent to basic-rate tax on the interest. So you pay 40pc tax on £20,000 (ie £8,000), less the 20pc credit (20pc of £13,000 = £2,600), meaning £5,400 for HMRC and £1,600 for you. Your tax bill has therefore gone up by 93pc.
Now, say Bank Rate – and in turn your mortgage rate – rises by a small fraction, lifting your mortgage cost to £15,000, while your rent remains at £20,000.
You will have to pay £5,000 tax in this scenario, so you make no profit at all.
So, these are the reasons why I see dark clouds over buy-to-let investments. Mind you, I do have clients that invest in this asset class but I can't win them all!
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Other helpful resources and viewpoints:
Buy to let is my pension but do the numbers stack up - The Telegraph
Why I am never going to own a home again - James Altucher
Point/Counterpoint on Real Estate as an Investment Option - Ben Carlson