Before answering that question, we need to qualify why investors are concerned. Their concern is the result of moves made by former chancellor George Osborne in 2015. As you may remember, affordable housing advocates and their allies in government managed to convince Osborne to take action that would make buy-to-let investing less attractive. Osborne offered two solutions:
- Higher Stamp Duty – After reducing stamp duty a year earlier to encourage people to buy property, Osborne decided to increase the duty on all property purchases above and beyond a person's primary residence. That means landlords pay more stamp duty now whenever they buy a new property.
- Mortgage Interest Tax Relief – Because buy-to-let property has traditionally been viewed as an investment, landlords have been able to claim mortgage interest as an expense. From 2017, that changes. Over a four-year period, the amount of mortgage interest that can be claimed for tax relief will be reduced until it settles at the basic rate.
The inevitable result is that landlords will have more taxable income at the end of the year. This is essentially a double-edged sword. Not only will they lose significant tax relief, but they will also pay income tax at a higher rate because their income will be higher.
Investment Strategies Will Have to Change
It should be clear that alterations to stamp duty and mortgage interest tax relief will necessitate changes to investment strategies among property investors. The individual investor's current position will dictate what kinds of changes must be made.
Investors with significant volumes of property already in their portfolios may be able to weather the changes without any dramatic effects. They can absorb the higher stamp duty or, if they are good negotiators, use it to negotiate better purchase prices. As for the mortgage interest problem, it might be possible to redirect all profits for the next few years into paying off existing mortgages before 2021.
Investors who can do this will find that buy-to-let does still make sense. The income that rental property generates usually surpasses anything an investor can get from most other asset classes.
Things are different for new investors or those with considerably smaller portfolios. For example, the first time investor looking to acquire an initial property now has to consider stamp duty and mortgage interest. Stamp duty is still probably a non-factor because it can be used to negotiate better prices, but mortgage interest will be a problem.
The new investor will have to charge a rental rate high enough to cover the additional income and the taxes it will require. But can rents be raised high enough to cover losses? That remains to be seen.
Buy-to-Let vs Pensions
Most of the discussion regarding whether buy-to-let still make sense or not is focused only on straight ROI. If that is the only factor, perhaps property is no longer attractive. The government's changes will inevitably reduce ROI to some extent. But viewed another way, property may still be a good deal.
Let us consider buy-to-let compared to pensions. We will start with defined-benefit pensions that are supported almost entirely by gilts. Employers are rapidly phasing out their defined-benefit schemes because low interest rates continue to decimate gilt yields. Meanwhile, schemes are building up impressive deficits to the point that some suggest they may not be able to meet future obligations.
Moving on to defined contribution schemes, these offer returns commensurate with investment performance. Some of these schemes do very well while others are marginal.
The question is this: has the investor put enough into a pension to generate significant returns by the time retirement arrives? If so, buy-to-let may not be worth the risk. If not, buy-to-let property may be just what the investor needs to generate significant retirement income.
Investors need to remember that buy-to-let property generates monthly income even as property values continues to grow. Once a pension is cashed out or used to purchase an annuity, growth immediately stops. It is only a matter of time before all of the income built up by the pension saver is gone. With property, the investor can continue to generate income until death. Properties can then be sold and the proceeds distributed to heirs.
Keys to Property Investing
Buy-to-let property still makes sense if the investor can build a portfolio strong enough to overcome tax relief changes. If not, other opportunities should be sought. Those who do choose to invest in property should keep in mind the following keys to success:
- Purchase Price – A good a rule of thumb is to pay no more than 100 times projected rental yield to acquire property. For example, the investor should not spend more than £80,000 on a property that would likely generate £800 per month.
- Rental Value/Mortgages – Banks only approve buy-to-let mortgages if the rental value of a given property is at least 125% of the monthly mortgage payment. That means for every £100 the investor pays for the mortgage, he/she must collect at least £125 in rent.
- Property Selection – Buy-to-let investing does not make sense if an investor shops on the retail market. Retail prices are simply too high. Therefore, investors must focus on repossessions, short sales, vacated homes, and other low-price, off-market properties.
No asset class is perfect in every way; not even property. But buy-to-let does continue to be a very attractive investment for those who can make it work. Don't discount it just because you hear one of the experts dismissing it. Look into it and see if it can help you reach your financial goals.