When deciding to invest in a second home, you face a choice: holiday lets for short-term rentals or long-term buy-to-let.
Recent years have seen shifts in the property market due to tax rule changes, prompting some landlords to leave the buy-to-let market. Both options can be profitable, but careful consideration is necessary. Factors like rental yields, tax implications, management, and your investment goals play a crucial role. Let’s explore the advantages and disadvantages of each strategy to help you make an informed decision.
What is the difference between a holiday let and a long-term let?
A short-term holiday let involves renting a property to holidaymakers for brief periods, often as short as 3 nights or up to 31 days. To qualify as a furnished holiday let (FHL) for tax purposes, it must be available for rent for at least 210 days annually and commercially let for at least 105 days, excluding personal use or rentals to family and friends.
In contrast, a long-term let, commonly known as buy-to-lets, typically involves renting a property for 6 to 12 months at a stretch.
A holiday let is a property investment, differing notably from traditional buy-to-let. The primary difference lies in the tenancy duration, with holiday lets typically lasting days or weeks, not months or years like traditional rentals.
Specific occupancy rules apply to holiday lets. While investors can use a holiday property for personal trips, HMRC mandates that it must be available for furnished holiday rentals for at least 210 days annually. Additionally, it must be rented to the public for at least 105 days each year, with days rented to friends or family at reduced rates or free not counting towards this total.
Getting a holiday let mortgage – what do lenders look at?
Affordability plays a critical role in mortgage applications, especially for holiday lets due to income variability. Unlike traditional buy-to-let properties with consistent monthly rent, holiday lets experience seasonal demand fluctuations, resulting in varying rental incomes.
To assess affordability, lenders calculate the average weekly rental income for low, medium, and high seasons and derive a single figure. This figure guides lenders in determining the loan amount for holiday let purchases or refinancing.
Borrowers may provide these figures based on their property ownership experience. Alternatively, for prospective holiday let buyers, local holiday letting agencies may compile the data on their behalf.
Facts to consider:
1. Financial return:
- Property returns depend on location and property type. Urban buy-to-lets offer consistent returns, while holiday lets vary due to occupancy rules. In rural or tourist areas, holiday lets often yield higher returns.
- Capital gains are unpredictable, but holiday lets, especially unique or period properties, stand out from urban flats.
- Consider profit consistency. Buy-to-lets have stable monthly income, while holiday lets are more seasonal, thriving in warmer months.
- Profit reliability varies. Holiday lets rely on numerous bookings, offering consistent income with maintenance and marketing. Buy-to-lets depend on single tenancy contracts, which can lead to void periods and profit fluctuations.
- Tax changes impact buy-to-let profits. Limited mortgage interest deductions can turn the business case negative.
- Furnished holiday lets, considered a business by HMRC, allow unlimited mortgage interest deductions, reducing income tax bills significantly, especially for higher-rate taxpayers.
- Selling a holiday let may qualify for capital gains tax reliefs like Entrepreneurs Relief, reducing tax to 10%. Compare this to the 28% for higher rate taxpayers on buy-to-let properties.
- HMRC contests, but holiday let properties are seen as Business Property for inheritance tax purposes, potentially up to 100% exempt upon transfer.
3. Level of hassle:
- Holiday rentals demand higher upkeep, involving regular housekeeping, addressing guest concerns, and property maintenance. Buy-to-let properties require less frequent maintenance but pose potential hassles, especially if property damage is discovered after a tenancy ends. Tenant issues can also arise, leading to prolonged occupancy.
- Buy-to-let tenants hold legally-recognized status with rights and protections, ensuring undisturbed living conditions and guarding against unfair eviction to protect vulnerable individuals. In contrast, holiday let guests have a ‘license to occupy,’ with limited rights defined by booking conditions.
4. Availability of mortgage finance:
- Holiday let mortgages often fall under specialist finance and may not be well-understood by mortgage brokers in the broader market. Holiday Cottage Mortgages aims to address this issue (see About Us for more details).
- Buy-to-let mortgages are readily available, with the remortgage market being more active in recent times.
- Both financing options are typically assessed using the rental income cover ratio, typically set at 140% to 145%, utilizing a stressed interest rate of 5.5%. This means lenders base loan decisions on the expected monthly rental income.
Both holiday lets and buy-to-lets have their pros and cons, but holiday lets can offer financial, personal, and tax advantages when chosen and managed wisely. However, it’s crucial to understand that running a holiday let as a business typically involves more work and year-round involvement, though outsourcing to a housekeeper or letting agent is an option.
Before deciding between these property types, it’s essential to assess your overall financial and personal requirements to determine which suits your needs best.