Buy-to-let landlords face uncertain future due to government meddling

Government moves to clampdown on letting fees and cuts to mortgage interest tax relief lead Emma Lunnto ask if the good times are over.

Thousands of investors who put their cash into the private rented sector over the past 20 years have seen spectacular returns from a combination of growing demand, rising house prices, widely available mortgages and, for the past eight years, rock-bottom interest rates.

However, the private rented sector has become a very different place in the past couple of years. The Treasury is coming after landlords with a multi-pronged attack on profits, while regulatory changes mean tighter lending criteria for buy-to-let mortgages.

At the same time resentment is growing from tenants who are campaigning for rent controls, longer tenancies and the scrapping of ‘no fault’ evictions. New legislation working its way through parliament will ban letting agents from charging tenants fees for setting up a tenancy – landlords alone will bear agents’ costs in the future.

Is the party over for small fry?

All of these factors combined have led to speculation that the party could be over for amateur landlords. That’s supported by evidence: figures from Connells Survey & Valuation show a fall in investment by small-scale landlords. Buy-to-let valuations dipped to 7 per cent of market activity in April, 6 percentage points below the five-year average for April. The estate agency says the decline in buy-to-let valuations has likely been driven by the stamp duty surcharge and the cut to buy-to-let mortgage tax relief.

Since April 2016, anyone buying a second home, including landlords expanding their portfolios, has been charged a 3 per cent stamp duty surcharge. Then April 2017 saw the amount of mortgage interest tax relief landlords can claim starting to be scaled back; by 2020, landlords will only be able to claim tax relief at the basic rate of 20 per cent. As a rough estimate, if you are a higher-rate taxpayer, increased taxation will wipe out your returns if your mortgage interest is 75 per cent or more of your rental income.

-Tougher times ahead for buy-to-let investors

John Bagshaw, corporate services director of Connells, says the government’s ‘anti-landlord’ policies have been hitting smaller players. ‘Buy-to-let used to be seen as a viable way to gain additional income or to fund retirements, but the gradual removal of buy-to-let mortgage tax relief will make it much harder for the average person to invest,’ he says.

His view is supported by figures from LendInvest’s Buy to Let Index for June 2017. It shows that although the top 10 buy-to-let areas are all reporting yields of more than 4 per cent, transaction volumes are down in every area.

Rob Bence, co-founder of The Property Hub, agrees that smaller landlords are most affected by the tax hikes and says the big players will be unaffected. ‘It doesn’t mean those landlords who are being hit by the changes should sell up and get out of the market, however; there are steps that can be taken to reduce the impact – such as making use of a spouse’s tax allowance or selling one property and using the funds to reduce the mortgage on remaining properties,’ he says. ‘I think what the government hasn’t realised, though, is that it’s targeting the small landlords with relatively small portfolios, while the super-rich landlords will be able to carry on as they were.’

Several organisations, including the Residential Landlords Association (RLA), predict the tax hikes will drive up rents. However, there is little evidence of this so far. According to HomeLet, which tracks rents across the country, rents in London fell by 3 per cent in May 2017 compared to May 2016 – the most substantial fall for eight years. Across the UK, average rents were 0.3 per cent lower in May 2017 than May 2016.

-Bank of England given new powers to curb buy-to-let lending

It’s vital to take independent financial and tax advice before investing in your first, or additional, properties. Whether you invest as an individual, a couple, a partnership or via a limited company will impact the way your rental income is taxed. It’s also vital landlords do their homework before buying a property. Is there sufficient rental demand in the area?

‘Consider the other properties in the area, the type of tenants the property is likely to attract, and any issues with the area that might put people off,’ says Bence. ‘All too often amateur landlords will snap up a dirt-cheap, rundown property, give it a half-hearted makeover and think they can charge a high rent for it. Knowing who you’re catering for is key.’

The quality of private rented homes is becoming more important than ever, not just because councils are clamping down on rogue landlords, but because private landlords now face increased competition from professional build-to-rent providers. Corporate-style landlords such as Get Living, Essential Living and Fizzy Living are building apartment blocks with on-site amenities such as gyms, swimming pools and meeting areas. Longer tenancies are offered as standard, often with no set-up or renewal fees.

Looking at the bigger picture, UK rental demand is expected to grow. LSL Property Services estimates that by 2025 more than a quarter of all households will rent privately, and that renter numbers will increase by one million in the next five years.

Landlords selling up

However, despite a predicted increase in demand, an increasing number of landlords are considering selling up. A survey by Axa found that 21 per cent of landlords are planning to sell all their rental properties, 10 per cent will reduce their portfolio, and 7 per cent will switch to commercial property ownership.

But currently it remains to be seen whether the great buy-to-let sell-off will actually happen. If it does, some experts are questioning who will buy the homes: first-time buyers or other, larger landlords? Kate Faulkner of says many would-be first-time buyers will still have affordability issues. ‘Take a two-bed semi in Oxford. It lets for £1,250 a month and is worth £400,000.

A first-time buyer would need £50,000 for a 10 per cent deposit plus buying costs, and then would have to pay nearly £1,800 a month plus maintenance costs, buildings insurance etc. If they are renting because they can’t afford this now, how will they “magically” be able to buy?’ she asks.

Meanwhile, mid-scale landlords who choose to stay in the market may soon find refinancing isn’t easy, after new regulations come into effect. From 30 September 2017, borrowers with four or more mortgaged buy-to-let properties will be classified as ‘portfolio landlords’ and subject to specialist underwriting standards. Lenders will be obliged to stress-test affordability on the whole portfolio, not just the subject property.

Landlords in the sector for the long term have several options to reduce their tax liability or increase their profit. An increasing number are choosing to buy and hold properties as limited companies (see below). Other alternatives include exploring niche, high-yielding sectors of the market such as houses in multiple occupation (HMOs) or serviced accommodation (for Airbnb style lettings).

An obvious solution for all landlords is to increase rents, passing on a proportion of the extra costs to tenants. Those married to or in a civil partnership with a basic rate taxpayer also have the option of transferring ownership of one or more properties to their spouse.

Incorporation could be a suitable alternative

Landlords looking to build a bigger portfolio could potentially set up a limited company to run their property business. Incorporated landlords are exempt from the tax hike as, instead of income tax, they pay corporation tax (currently 20 per cent). Limited companies can also deduct all their costs, including finance, from rental income for tax purposes.

Setting up a limited company is fairly straightforward and can be done cheaply online at Companies House. ‘Most landlords opt to set up a new company (or Special Purpose Vehicle) rather than using an existing trading limited company because there are more buy-to-let mortgage products available to SPVs than to trading businesses, which require infinitely more expertise to underwrite,’ says David Whittaker, chief executive of Mortgages for Business. ‘At the moment, there are more than 260 buy-to-let mortgages available to SPVs – that’s nearly a quarter of all products, so choice is good.’

However, incorporation is a big step and won’t be suitable for everyone. If an individual landlord sells a property to their own limited company or SPV, they’ll need to do so at the market rate and pay stamp duty and capital gains tax as appropriate. These costs will eat into the savings achieved by incorporating, making it vital to take professional financial and tax advice before going ahead.

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