The buy-to-let landscape has witnessed substantial transformations owing to shifts in mortgage interest relief and the implementation of a stamp duty surcharge for second properties. These tax adjustments have prompted a reevaluation of the profitability of buy-to-let investments. Landlords have seen a reduction in their returns due to these changes, leading to a critical question: Is buy-to-let still a financially viable income stream?
In the wake of these alterations, prospective property investors are grappling with the sustainability of this avenue for income generation. The evolving tax environment has placed buy-to-let investments in a new light, compelling both novice and seasoned landlords to adapt to the changing dynamics of the property market. As they weigh the pros and cons, they seek answers about the future of buy-to-let in the realm of financial growth.
What are the changes in buy-to-let?
Property price growth has slowed down in recent years, introducing more risk into the buy-to-let landscape compared to its historically stable performance. Concurrently, the government has adopted a tougher stance on the buy-to-let market through significant tax system changes.
In 2016, the government introduced a 3% surcharge on stamp duty for additional properties, encompassing second homes and buy-to-let properties. Then, in 2017, the government began phasing out mortgage interest relief, a policy that had previously allowed landlords to deduct their mortgage interest payments before calculating their tax liability.
Previously, higher-rate taxpayers enjoyed a generous 40% tax relief on their mortgage payments. However, the new approach provides landlords with a flat-rate tax credit equivalent to 20% of their mortgage interest. While this change won’t negatively impact most landlords who were already considered basic-rate taxpayers, it will notably affect those in higher or top-rate tax brackets.
One important factor to consider is that landlords must now declare the income used to cover their mortgages on their tax returns. This is a departure from the old system, where they could declare rental income after deducting mortgage repayments. The apparent increase in income might potentially push some landlords from the basic rate to the higher tax bracket, resulting in a higher tax liability.
How have buy-to-let profits changed?
Mortgage interest relief, once a landlord benefit, has been gradually reduced, significantly reducing profits for many, especially those in higher tax brackets. This change effectively cuts their tax relief in half from the previous 40%.
These changes have a notable impact on landlords with interest-only mortgages, which are the most common, and who fall into higher tax rate categories. To illustrate the impact, let’s look at an example: a landlord paying £500 per month in mortgage interest and earning £1,000 per month in rent.
|Annual rental income||£12,000||£12,000|
|Annual mortgage interest||£6,000||£6,000|
|Taxable annual income||£6,000||£12,000|
|Tax credit of mortgage interest||0% (£0)||+20% (+£1,200)|
|Tax bill (lower rate)||£1,200||£1,200|
|Tax bill (higher rate)||£2,400||£3,600|
Is buy-to-let still a worthy investment in 2023?
When deciding if buy-to-let is a suitable investment, tax considerations are just one piece of the puzzle. Your investment goals and financial needs play a crucial role, and it’s essential to weigh the pros and cons:
Advantages of buy-to-let:
- You have the potential to earn rental income, with some areas like Liverpool, Glasgow, and Leicester offering rental yields of around 8%.
- Property values may appreciate over time, leading to capital growth.
- Insurance options are available to protect against rental income loss, damages, and legal expenses.
Disadvantages of buy-to-let:
- Increased taxation can have a negative impact on your profits.
- Vacancies in your property can lead to income loss if not properly insured.
- Property price drops can reduce your capital, especially if you have an interest-only mortgage.
- Additional costs, such as stamp duty, insurance, and maintenance, should be taken into account.
- Managing rental properties comes with significant responsibilities.
- Some individuals use buy-to-let as a source of retirement income, withdrawing substantial sums from their pension savings for this purpose.
Should I stay or should I go?
Buy-to-let investors find themselves facing complex decisions about whether to sell and what to sell. The financial implications tied to mortgage rates can vary significantly, depending on borrowing levels and property yields. The impact is more pronounced for landlords in London and the south-east, where house prices are considerably higher. Data from Q4 2022 reveals that average yields in these regions hover around 5%, notably lower than in the north of England, where figures of 7.5-8% are observed in cities like Liverpool and Newcastle.
Monthly profitability plays a crucial role for lenders who typically seek a minimum interest coverage ratio of 125% (the ratio of gross rental income to mortgage interest payments) when considering buy-to-let mortgage applications.
For landlords at a crossroads, energy efficiency concerns might tip the scales in their decisions. Robert Salter, director at Blick Rothenberg, points out that many rental properties are aging and require costly energy efficiency upgrades. “I can certainly understand why landlords with properties rated EPC D or lower might be contemplating selling at this time,” he comments. Under government proposals, landlords may face the requirement to invest up to £10,000 in energy efficiency improvements, irrespective of property value or rent.
Initiatives like energy efficiency requirements underscore the government’s interest in professionalizing the buy-to-let sector. Landlords who choose to stay should prepare for increased regulation and scrutiny. Rob Morgan, chief investment analyst at Charles Stanley, advises viewing buy-to-let as a “mini business” rather than a passive investment.
In this context, he suggests that buy-to-let can be a viable way to supplement the pensions of individuals in their 50s and 60s, who have accumulated experience and contacts but are still energetic. However, he acknowledges that preferences may change as individuals age. “I’m not sure you’ll want tenants calling you in the middle of the night to report a broken boiler,” he adds.
How do I get started with buy-to-let?
Your journey to becoming a landlord will typically involve five steps:
Step 1 – Organize Your Finances:
Kickstart your buy-to-let journey by consulting a financial adviser to determine your investment budget and target returns. It’s also a good idea to seek guidance from a mortgage broker to secure the best deal or obtain a mortgage in principle, ensuring you’re well-prepared to make offers when you stumble upon the right property.
Step 2 – Find and Secure Your Property:
The process of locating and having your offer accepted on a rental property can be relatively swift, but it’s prudent to allocate a few months for this stage, just in case.
Step 3 – Obtain Insurance:
In addition to buildings insurance, consider safeguarding yourself against unforeseen costs like tenant injuries, property damage, and loss of rent.
Step 4 – Attract Tenants:
You can choose between using an agency or finding tenants privately, depending on your preferred level of involvement. Regardless of the method, it’s crucial to always draft a legally binding contract, even if you know your tenants well, as it can help prevent disputes that might strain relationships.
Step 5 – Actively Manage Your Buy-to-Let Investment:
Buy-to-let investments require hands-on management. Regularly review your mortgage terms when your current deal expires and make sure to carry out necessary property maintenance. It’s also important to optimize your income from your buy-to-let property in a tax-efficient manner, an area where the expertise of an accountant can be quite valuable.