There is a very strong British love for investing in property. Owning your own home, owning a second property and investing in property to rent out (and hopefully realise a future capital gain from) are common aspirations here. All have a strong foundation in a basic belief that you cannot go wrong with bricks and mortar. You can, of course, but the experience of most over time has been pretty positive.
Buying a home or a second property for private use has a mix of personal and financial motivations. The personal motivations are obvious: we all like stability and security, and a place to live is a pretty good starting point for the achievement of those objectives. If it makes sense financially as well you are sorted.
But how about a pure investment play into a buy-to-let property? There are a few factors to take into account, including:
- Available funds
- Existing investment exposure to residential property (including one’s own home)
- The necessity, availability and attraction of borrowing to fund all or part of the investment
- The “hassle” of being a landlord. With potential return comes responsibility
- The returns, both in the form of rental yield (net of expenses) and realisable capital growth
The last point is a really important factor to keep in mind when assessing the likely net rental yield and capital growth. However, the reliefs available to landlords make tax a quite positive and even exciting subject.
Let’s look at the all-important “money in/money out” equation. A recent survey of buy-to-let hotspots carried out by the Telegraph revealed gross rental yields of between 5.5 and 7.6 per cent. To arrive at the net yield you need to factor in costs and then consider taxation. In arriving at the taxable yield, whether or not an expense is tax deductible will be critically important.
The following expenses that a landlord will need to consider are tax deductible:
- Mortgage arrangement fees
- Mortgage interest (not any capital repayment)
- Letting agent fees (10 to 15 per cent of the rent plus VAT)
- Advertising for a tenant (say, £300-£400 per new tenant)
- Maintenance and repairs (renovations but not enhancements)
- Wear and tear on furniture (round sum 10 per cent of the rent minus any costs paid on behalf of the tenant)
- Ground rent and service
- Other direct costs of letting (for example, phone calls and travel between properties).
The general counsel of caution is to keep proof of all expenses in case it is required by HM Revenue & Customs.
All very well but what does it mean in real money? As the example in the box out shows tax deductibility of the key items of expenditure helps to reduce tax costs and thus improves the net of tax yield.
In assessing the attractiveness of returns on buy-to-let property it is important to consider the likelihood and extent of capital appreciation too. Here, however, the impact of capital gains tax at 18 per cent for basic rate taxpayers or 28 per cent for higher/additional rate taxpayers needs to be kept firmly in mind, as does the fact gains are “lumpy” as you cannot generally sell part of a property.
Tony Wickenden is joint managing director of Technical Connection
Example: The benefits of landlords’ tax reliefs
Let’s take a flat in East London worth £500,000 that yields a gross rent of £2,500 per month or £30,000 per annum: a gross yield of 6 per cent. If the purchase were funded by an interest-only mortgage of, say, £300,000, the net (and taxable) position could look like this:
Less mortgage interest (at 4.5 per cent after an initial lower interest period): £13,500
Less additional costs at 15 per cent of the rent (including insurance and maintenance): £4,500
Less letting agent costs at 10 per cent (plus VAT) of the rent: £3,600
Tax (assuming 40 per cent) on £8,400 (£30,000 rent – £21,600): £3,360
Total net costs: £24,960
Net rent received: £5,040
The net yield pre-tax, based on the gross purchase price, will be 1.7 per cent (£8,400 on £500,000). The net yield post-tax will be 1.01 per cent.
If mortgage rates increased by, say, 1 per cent to 5.5 per cent this would add £3,000 per annum to costs reducing the pre-tax yield to £5,400 (1.1 per cent) and the post-tax yield to £3,240 (0.65 per cent). Not much margin for error.
All of these yield figures, of course, are based on the full cost of the property, including the borrowed sum.