How solid are bricks and mortar?

property investment

Buy-to-let has been a popular investment choice amid rising property prices and a growing number of renters. This may be changing as the government and the regulator continue to focus their attention on supporting housing supply and low-cost home ownership.

Prospective landlords may have found their ability to enter the market hampered by the Stamp Duty Land Tax (SDLT) increases last April and existing landlords will soon be hit by another change to the tax regime. As it gets more expensive to branch out into property, does buy-to-let still represent a good investment?

Buy-to-let has been seen as an attractive means of generating additional income in recent years, as evidenced from the fact the market grew from 840,000 mortgages in 2006 to 1.8m by the end of 2015, according to data from the Council of Mortgage Lenders. The average UK rental value was £888pcm in January and house prices have risen by, on average, 7% a year since 1980, according to the Office for National Statistics (ONS).

Investing in bricks and mortar has become increasingly expensive, however, and is set to get more so. As part of the government’s Five Point Plan for housing, SDLT rates went up in April 2016 by 3% on additional residential properties worth more than £40,000, such as buy-to-let properties and second homes.

Previously, STLD did not apply on the first £125,000 of a property but this has since been replaced by a 3% charge. When these changes are applied to the average UK house price, which is £219,544 according to data from the ONS, it becomes clear just how much more expensive it has become.

Prior to April 2016, the first £125,000 of the £219,544 would not have been subject to SDLT and the remaining £94,544 would have been taxed at a rate of 2%. The total SDLT bill for an average UK property would have been £1,890.88. Since the rules were changed, the first £125,000 is taxed at 3% (£3,750) and the remaining £94,544 is taxed at 5% (£4,727.20), taking the total SDLT bill for the same property to £8,477.20.

While this tax hike only really hit those either looking to purchase their first BTL/secondary property or those looking to expand their property portfolio, another change to the tax regime in April 2017 will also hit landlords in particular.

The tax relief that landlords of residential properties get for finance costs, including mortgage interest payments, will be restricted to the basic rate of income tax which will be phased in over a four-year period. In essence, turnover will be subject to tax rather than profit.

Landlords could previously deduct finance costs from their rental profits in order to bring down the amount which would be subject to income tax. Between April 2017 and April 2020, this tax relief will be gradually phased out, leaving landlords exposed to larger income tax bills.

For example, if a landlord has rental income of £50,000 a year, allowable expenses of £10,000 and mortgage interest payments of £30,000, the net profit would be £10,000 under the current rules. Once the new rules have been fully phased in, the net profit will be counted as £40,000.

A 20% tax reduction will then be applied to whichever is the lower of the finance costs, property profits, or adjustment total income.

The government estimates that 82% of landlords won’t have additional tax to pay under the new rules because their total income won’t exceed the higher rate threshold of £43,001. Higher rate taxpayers will be understandably wary, however.

Lastly, landlords will be taxed on capital gains at 28% on property transactions (BTL) as opposed to the normal rate of 20%.

If many will be largely unaffected by the changes they will undoubtedly take their toll on others. The direction of travel for landlords looks less positive, especially considering the Bank of England elected to impose regulations on buy-to-let lending for the first time in January. Lenders are now required to stress test the affordability of mortgages for BTL borrowers at a rate of 5.5%, for example. A number of lenders have also raised their interest coverage ratio – the rental income required to cover mortgage interest costs – from 125% of the interest payments to 145%

An alternative to investing in assets like property is to invest in a combination assets such as shares, bonds, and cash, and to take advantage of tax-efficient wrappers such as pensions and ISAs.  The success of a diverse portfolio depends on the performance of those assets. Investors should always consider their personal circumstances and requirements before investing.


The above article was first published by Charles Stanley on 1st March 2017.