PLANNING FOR MY RETIREMENT

Buy to let: a solid foundation?

  • 16 October 2019
  • 5 mins
  • Buy-to-let investing has become popular in recent years as demand for rented accommodation has continued to rise and as the income returns from bonds has fallen to multi-century lows.

  • Investing in the right property in the right area can offer a combination of rental income and capital gains.

  • But properties require upkeep, rentals are not guaranteed, and you may not be able to sell your investment at short notice.


In recent years there has been an increased interest in the buy-to-let market either on a long-term basis or as holiday lets. Viewers of the BBC’s Homes Under the Hammer are quite used to seeing investors achieve yields of between 6½% and 9%. Even a mouth-watering 13.5% in one instance. And adverts for student accommodation schemes are guaranteeing a 9% return for at least five years; basically assuring investors of getting almost half their money back over that period, assuming there are no ancillary costs such as maintenance fees and/or mortgage fees and interest. Meanwhile, the yields on government bonds are at multi-century lows; and are even negative once we take the effects of inflation into account. In this investment briefing we take a closer look at the buy-to-let market, its potential benefits and its risks.

Why invest in property? Property is often said to combine bond-like income with equity-like capital returns and on the whole its long-term performance can lie somewhere between these two asset classes. The income comes from the rents paid by tenants, while the potential for capital returns comes from increases in a property’s value. However, property returns are very closely linked to the domestic economy.

  • When the economy is doing well, there is an increased need for both residential and commercial properties.

  • Conversely, when the economy is doing badly, tenants can become bankrupt or decide to down size, and this can lead to falling rents and declining property values.

You can offset costs against tax. Each tax year you will need to fill in a Self-Assessment Tax Return for HMRC* and pay a tax bill, but you can offset some of the cost against tax, including:

  • Interest on your buy-to-let mortgage repayments (see Risks of investing in property, below).

  • Fees paid to letting agents.

  • Council tax and bills (if you pay them for the property).

  • Cost of advertising your rental property.

  • Paying for repairs.

You can also get tax relief to cover renovations to furnishings, carpets and sofas as well as maintenance repairs; but not on property improvements like an extension.

Since April 2016, you have only been able to claim for renovation costs as and when they occur.

Doubling down: the power of borrowing

However, buying a property is very capital intensive and can exceed many people’s entire savings including their pension pot. Unless we are very wealthy most of us can only afford one property outright: the financial equivalent of putting all your eggs in one basket. But investing in property gives you access to one tool that is not readily available when investing in stocks or bonds: leverage. This is borrowing money to invest with the aim of making a higher return than the costs of servicing the loan. If you want to buy a stock, you have to pay its full value up front when you place the order. But by using financing you can “own” and control a property the minute the contracts complete whilst committing a fraction of the total value up front (the deposit). If you decide to apply for a buy-to-let mortgage, you'll need a much higher deposit – up to 40% of the value of the property – and lenders may require a rental income that’s around 125% of your monthly mortgage repayments. You can also expect to pay higher interest rates because there's greater risk to the lender. Set-up fees can also be more expensive. But using the financing route has emboldened some private landlords to take out a second mortgage on their personal homes to use as a deposit on two or three other properties.

YOUR HOME MAY BE REPOSSESSED IF YOU DO NOT KEEP UP REPAYMENTS ON YOUR MORTGAGE.

Risks of investing in property

  • Property can provide a regular income stream with the potential to increase faster than the rate of inflation.

  • Property can provide long-term capital returns.

  • Property returns are independent of equity and bond markets so have the potential to diversify a portfolio.

  • Demand for property is closely linked to the health of the economy.

  • Property values can only be certain at the point of sale; all other valuations are subject to personal opinion.

  • Property can be difficult to sell and you might not realise the full value of your investment at short notice.

  • Property prices and demand for rentals can go down as well as up, and you might get back less than you originally invested.

* Schroders Personal Wealth does not offer tax advice and a professional opinion should always be sought as tax rules can be subject to change and depend on individual circumstances.

The income received will need to be declared on your annual tax returns although you can offset mortgage interest payments and some costs against this.

  • Higher and additional rates of tax relief are being phased out and will be replaced by a 20% allowance for all landlords by April 2020.

  • If you make a profit when you sell your buy-to-let property, you’ll be liable to pay Capital Gains Tax, although some capital investments can be offset against your gains.

Buy-to-let investing is very different to owning your own home; you’re effectively running a small business.

Buying and selling costs are high compared to other forms of investing with estate agent and surveyor fees, stamp duty, land tax, and solicitors’ and conveyancing fees to consider. From 1 April 2016, second homes and buy-to-let properties have attracted an extra 3% on top of the appropriate Stamp Duty band. Selling a property can take a long time if demand for properties is low and it may be difficult to convert your investment to cash quickly. And whilst having a sitting tenant can be a bonus for another property investor, it can put off people looking to buy a home for themselves. And keep in mind that if using a mortgage or other financing to invest in property, this can come with additional, sometimes significant, risks:

  • If your property remains empty for a long period you will need to meet repayments from other sources of income or from your savings.

  • In extreme cases your property – even your home – could be repossessed.

So if you are tempted to raise a second mortgage to buy a property consider it in these terms:

  • you would be taking out a very large loan that accrues interest…

  • to buy something that costs money to maintain (insurance, upkeep, etc) and …

  • offers an uncertain income stream (the property might not be let for the whole duration of your ownership).

Regulatory change

Finally, the government has been actively legislating to make this sector less attractive to landlords. As we have seen, it is reducing the ability to offset your borrowing costs against your income, and is moving responsibility for some of the costs associated with setting up a new rental agreement from the renter to the landlord. This has had some success and investment by private landlords is falling as a percentage of the total market share. While corporate landlords benefit from more benign tax treatment, their borrowing costs are more expensive as commercial interest rates are much higher.

Conclusion

Property can play an important role in a diversified portfolio. It is why we include commercial property in our discretionary models:

  • It can provide regular and increasing income streams with the potential for long-term capital returns.

  • It can also reduce risk at the portfolio level as its returns move independently of the other major asset classes.

But property should be considered in the context of your total investment portfolio. Taken with the value of your own home, buying an investment property might leave you highly exposed to a single asset class: the UK domestic property market.

Building your own property portfolio requires not only a significant monetary commitment but also the time to research the market and manage the physical assets.

If you are thinking of investing in the property market but are concerned about diversification, speak to your Personal Wealth Adviser. If you are considering taking out a mortgage or other loan to fund a property purchase, we can also introduce you to our specialist lending team.

Lending is subject to an assessment of your circumstances. Overdrafts are subject to status and application and repayable in full on demand.

YOUR HOME IS AT RISK IF YOU DO NOT KEEP UP REPAYMENTS ON YOUR MORTGAGE.

Important information

Any views expressed are our in-house views as at the time of publishing.

Eligibility criteria and fees and charges apply at Schroders Personal Wealth.

This content may not be used, copied, quoted, circulated or otherwise disclosed (in whole or in part) without our prior written consent.

Let's start with a free consultation

No fees. No commitment. No obligation to buy. Let's just see how we can help

Tap into some of the finest minds in the business

Our regular newsletters are packed with food for thought. Sign up for expert views and opinions, and choose which areas of financial planning and investment you’d like to hear about.

This site is protected by reCAPTCHA and the Google privacy policy and terms of service apply.

Selected articles