What are the prospects for buy-to-let investors as they grapple with a raft of changes that have combined to constrain returns?
Has the UK now passed peak buy-to-let? According to one piece of research, by London estate agent Ludlow Thompson, the number of BTL landlords reached a record 2.5 million in the 2017/18 tax year, up 27 per cent from 1.97 million in 2011/12. And landlords owned an average of 1.8 buy-to-let properties each – a figure that had risen for the fifth consecutive year. ‘Rising numbers of landlords show the enduring appeal of buy-to-let, particularly in London,’ says the company’s chairman Stephen Ludlow. ‘The long-term picture for the buy-to-let market remains strong,’ he adds bullishly.
But all around are other signs that the glory days for BTL are over. UK Finance, the financial services trade body, noted last December that the number of mortgages for new BTL purchases had dropped back to 2012 levels. By March 2018, loans to landlords were down by 20 per cent year-on-year.
And there have been growing signs of a sell-off taking place. Figures from ARLA Propertymark – the professional body for letting agents – published in June suggest that a record number of landlords are choosing to sell their buy-to-let properties and leave the sector. According to the data, during April letting agents reported a three year high for the volume of landlords selling their buy-to-let properties, with each branch reporting an average of five landlords looking to leave the market, up from four in March. Another survey in May by the National Landlords Association, meanwhile, suggests that around 20 per cent of landlords plan to sell up this year.
The reasons are not hard to discern. Over the last two years, BTL has received a kicking of a kind given to very few asset classes. First George Osborne, then chancellor, announced a 3 per cent additional stamp duty on all second homes, including BTL properties. Then came the announcement that income tax relief on costs, including mortgage interest, would be limited to the basic tax rate band – a move being phased in between 2017 and 2020. Given that many BTL landlords have built their empires through constantly remortgaging to borrow the maximum amount against rising property values, this was a potentially devastating blow.
These two headline moves have been followed up by a series of other financial and regulatory sanctions against BTL landlords (see box) that add up to a perfect storm. Mohammad Jamei, senior economist at UK Finance, sums it up: ‘Regulatory and tax changes are among several factors that are reducing confidence in the buy-to-let market. This has led to subdued house purchase activity by landlords since the middle of 2016 and we expect more of the same over the next two years.’
David Cox, ARLA Propertymark chief executive, sounds an equally downbeat note: ‘The barrage of legislative changes landlords have faced over the past few years, combined with political uncertainty, has meant the BTL market is becoming increasingly unattractive to investors.’
Nor is the pressure going away. As recently as June, the Conservative think-tank Onward was urging that the Treasury should go a step further and strip BTL landlords of all tax relief on mortgage payments, in a bid to make it easier for young people to get onto the housing ladder.
Putting the brakes on
The government’s initial motivations in moving against BTL were several. It wanted to put the brakes on a sector of the housing market seen by the Bank of England as unstable. It was responding to political pressure to give a better chance to first-time buyers who were perceived as being squeezed out of the market by avaricious BTL landlords. And of course, there was a very useful tax windfall to be gained by cracking down on a form of investment that had allowed a sizeable minority to accrue significant wealth over the last couple of decades.
There is evidence that these measures are already having an effect on the housing market – though not necessarily the one that was desired. Analysis by research company Residential Analysts shows the number of flats purchased in England and Wales fell by 10 per cent in the year to December 2017, compared to a fall of 2.1 per cent in all property transactions. This is significant because flats are the classic BTL purchase, but the data also suggest that first-time buyers have not been able to step in and pick up the slack as intended.
The question now is: what should BTL investors – and those still considering dipping their toe into the lettings market – do next?
For ‘newbies,’ the question is a simple one: to buy or not to buy. But the answer may differ, depending upon whether you are a lump sum investor – someone who’s taken a cash slice out of their pension, or received an inheritance, for example – or you are planning to take out a BTL mortgage.
There’s always the question of whether you’re cut out to be a landlord, with the time and hassle that owning a property entails; but beyond that, for the lump-sum investor it boils down to whether this is the best return you can get on your money.
BTL investors get their overall return via a combination of rental income and capital growth when prices rise. The general consensus is that both are under pressure, with house prices rising at somewhere between 0 and 2 per cent, and rental yields below historic levels, averaging around 4 per cent in London and the South East. By the time you’ve paid for maintenance and other unavoidable costs you could find yourself with precious little profit at the year end.
But that’s looking at the average; if you pick carefully, and especially in the right areas, you could do considerably better. The latest Buy to Let Index Quarterly Report from LendInvest shows that returns vary dramatically depending on location. LendInvest’s sales director Ian Boden says: ‘We don’t subscribe to the idea of a mass house price growth slowdown throughout the country. We wanted the index to show us where the slowdown is hitting hardest, and where the opportunities continue to abound for UK landlords and property investors alike.’
Colchester, for example, is currently identified as a BTL hotspot, with a rental yield of 3.7 per cent and a 12-month capital gain of 10 per cent, giving a total return of almost 14 per cent. But remember that the stamp duty of between 3 and 15 per cent has to be accounted for before you make a profit (assuming this is a second home). In east central London, in contrast, a 3.8 per cent price drop wipes out the meagre 2.9 per cent yield. With a mortgage, the borrowing rate must also be taken into account, notwithstanding the tax situation. You can get rates as low as 2.5 per cent (Coventry Building Society) but with hefty fees and a low LTV usually attached; 3-4 per cent is a more realistic estimate, and any rental profit only cuts in when yields pass this level. A combination of high yield and strong rental price growth offers the best indicator of consistent return going forward; in LendInvest’s survey Manchester comes out on top on that criterion, with yields averaging 5 per cent and rental growth of 3.7 per cent.
If you’re an existing BTL landlord, the decision about what to do next depends very much on the scale of investments and your tax situation. Mortgage lender Paragon identified the five most common strategies being pursued in response to tax changes –and the proportion taking each route – in a survey last year.
Common survival strategies
These were: increase rent (32 per cent); sell some properties and don’t buy any more (19 per cent); move ownership into a limited company (12 per cent); maintain current portfolio and don’t buy any more (10 per cent); and repay some or all buy-to-let mortgage debt (6 per cent).
Initially, many saw incorporation as the best option, because companies would not be affected by the abolition of higher rate income tax relief. This was especially true for those with larger portfolios including houses of multiple occupation (HMO), where the costs of running a limited company are more readily justified. However, increases to dividend tax – payable when the landlord takes their money out of the company –_have made that a far less attractive prospect.
One example modelled by Lee Sharpe from Taxinsider.co.uk considers the case of a woman with six properties generating £64,800 of rental income, and compares her tax position inside and outside a limited company. The conclusion is that while it is initially more expensive to run her business inside a company, by 2019/2020 she would be saving up to £3,651 tax within the company. However, this does not appear to take into account the costs of actually running the company. Landlords need to consult their accountant or tax adviser to make a decision on incorporation.
For the small-time landlord with one or two properties, it’s unlikely to be worth forming a company, and that means accepting that the days of higher-rate tax relief are over. Whether you decide to carry on in those circumstances will depend on your overall tax situation – and just how attached you are to your properties.