Buy-to-let ("BtL") properties in the UK has always been a great investment vehicle when you consider the low bank interest rate on credit bank balances. Up until a few years ago it seemed that almost everyone wanted to become an investor in real estate and own a property to let. Demand was strong and lenders were happily providing high Loan to Value (“LtV”) mortgages; investment returns were very attractive and the BtL sector looked unstoppable.
Then, a combination of changes in government taxation of BtL profits, in LtV ratios and other loan terms offered by lenders, plus the impressive rise of purpose-built properties in the competitive Build-to-rent ("BtR") sector meant that BtL properties lost some of their investment lustre, at least to the less experienced ‘arm chair’ investors.
BtL sector remains resilient
But, as we all know, the property market is cyclical and investment in BtL properties has proven to be resilient. The smart investors have come to terms with the changes and realise that, in 2021 and beyond, property investment in the rental sector can still be profitable.
It may be that the changes in the management of BtL rental properties and taxes have made investing slightly more complicated, but there are ways to adapt to such changes. With a long-term strategy, investors can still earn positive income in the short and long term.
So, let’s have a look at some of the demand drivers and changes, as well as how to effectively adapt to ensure BtL investment remains profitable.
Investment in real estate
Investing in real estate has long been accepted as a major wealth builder. Property is a tangible asset with secure ownership and generally its value rises over the long-term at least in-line with inflation rates, making it a great hedge against such inflationary pressures.
Additionally, property is also a flexible asset as it can be mortgaged, remortgaged to release some of the accumulated equity or obtain further funding; it can also be rented out or lived in.
By and large, property outperforms other investments over the long-term.
Rental demand remains strong
Across the UK there is still an undersupply of accommodation and the housing market is continuing to grow. This undersupply is coupled with a growing demand for rental property, which continues at high levels owing to three main demand drivers:
- The so-called “Silver Tsunami” which means that an ever increasing numbers of longer-living retirees are looking to rent properties, often after selling their homes and releasing their equity;
- Increasing numbers of “millennials” who have a different approach to home ownership than previous generations, many preferring to rent rather than buy; plus
- Affordability issues are challenging for many “aspiring” homeowners given the relatively high entry cost of first homes.
Financing is still available
Coupled with the growth in demand for BtL properties, many lenders are still interested in lending to the sector and there are a number of competitive products on the second-home mortgage market. Overall, BtL loans make up about 12% of the value of the new mortgage market.
With interest rates remaining at low levels, and likely to be so for the foreseeable future, borrowing is still affordable, especially as rental yields in the BtL sector can still produce positive cashflows after loan repayments.
Positive cashflows and potential capital appreciation
In summary, a combination of attractive yields (especially when compared with bank deposit rates) and excellent capital appreciation potential in certain areas of the UK, means that investment in BtL properties will likely remain popular. The more ‘savvy’ investors are now looking for ways to add value to the property, to facilitate stronger capital returns, by way of renovation, decorating or extending, to name but a few examples.
Dealing with changes impacting the BtL sector
The two major changes affecting the BtL sector have been in respect of taxation and legislation.
Taxation: tax bills are now higher for most BtL investors as, over the last few years, the government increased taxes for landlords and property investors. Furthermore, less tax relief is available and, since April 2020, private landlords can no longer deduct any of their mortgage expenses from their rental income to reduce tax bills. Instead, landlords receive a tax credit, which is based on 20% of mortgage interest payments.
The tax rate changes followed a 3% stamp duty surcharge which was levied in 2016 for those buying second homes or buy-to-let properties in the UK.
Legislation: there also have also been changes in legislation which have added some costs to the BtL property owner, including new electrical safety standards for all privately rented properties as all fixed electrical wiring and installations have to be checked and tested by a qualified electrician, at least every 5 years. Another example is the gas safety check, that’s required annually.
Notwithstanding the above, there are ways to adapt to these changes in the BtL sector and obtaining professional tax and legal advice to ensure that any BtL property investment is as tax efficient as possible. Setting up the appropriate ownership structure in place such as via a limited company rather than in an individual name can also help.
Limited companies can, for example, deduct mortgage expenses before calculating profit unlike those who are investing as individuals. Investing through a limited company also allows investors to pay corporation tax instead of income tax, which is currently lower than the higher rate of income tax.
There is still mainstream demand for investing in BtL properties, although mortgaged BtL purchases were down to around 64,500 in 2020, about 10% down from 2018 and 2019 levels.
The twin combination of good yields along with potential capital appreciation can produce a solid income in the short and long term—perhaps not as much as previously, but certainly more than many other investments.
