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How has buy-to-let changed and what’s the outlook?

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Written by: Sarah Davidson
20/07/2022
Buying a couple of properties to let to supplement your income in retirement used to be considered reasonably low risk – but regulation is changing that.

Here is how the private rented sector has changed over the past decade and why it’s increasingly the domain of professionals prepared to invest in large portfolios.

The demise of tax relief

In 2015 the then chancellor George Osborne announced private landlords would see their beneficial tax reliefs slashed over the coming years, dramatically shrinking buy-to-let’s profitability.

Under the previous Labour government, landlords could deduct mortgage interest and related costs from their income before calculating how much tax to pay.

Osborne phased this out over four years, replacing tax relief worth up to 45% for higher rate taxpayer landlords with a flat 20% tax credit for all private landlords by 2020.

The change meant landlords began to pay income tax on their revenue rather than their profit, dragging thousands of buy-to-let investors into higher rate tax and wiping out much of their profit margin.

More stamp duty

Another of Osborne’s policies saw landlords and anyone owning more than one property having to pay standard rates of stamp duty plus a 3% surcharge after April 2015.

The considerable uplift in investment costs, particularly in areas of the country where property prices were high, sent yields down and dampened the commercial case for investing in buy-to-let.

Bank of England crackdown

In January 2017 the Prudential Regulation Authority brought in rules restricting how much landlords could borrow from their mortgage lender.

Properties needed to have a higher rental income in relation to monthly mortgage payments than previously and for fixed rate mortgage deals less than five years, they had to demonstrate mortgage payments would still be met even if interest rates rose 3%.

Lenders also had to request information from landlords with 10 or more properties and assess how much debt they held across their portfolio, limiting them from taking on more leverage than they could have had previously.

Ownership changed

With the demise of tax relief on mortgage interest, landlords with larger portfolios took a disproportionately high hit to their profits.

With up to 45% tax payable on rental income for top band income tax payers – up to 60% for those whose income fell into the £100,000 to £125,000 bracket – it often made more sense to own buy-to-lets in a limited company structure.

This allowed income to remain in the company, corporation tax payable at 19% (due to rise to 25% in 2023) and other costs associated with running a limited company.

Investors could take money out as dividends, paying capital gains tax of between 18% and 28% depending on taxable income.

Transferring privately owned buy-to-lets directly to a limited company incurred capital gains tax to pay on the value of the property sold, and then stamp duty with the surcharge payable by the limited company on repurchase.

These costs rendered the transfer uneconomical in many cases, with landlords typically opting to buy new properties in a corporate structure while keeping existing lets in their own name.
Some landlords chose to convert ownership to a limited liability partnership, reducing capital gains tax payable, later switching to a limited company vehicle.

Search for yield

Taken together, these changes made it less attractive to be a landlord with just one or two properties in their own name.

Higher capital costs upfront also put pressure on yield, prompting landlords to seek out lower value properties in areas with growing demand for rental property.

This fuelled a rise in the number of investors buying up property in the north of England and in the country’s regional cities including Leeds, Manchester, Liverpool, Birmingham and Newcastle where capital outlay was proportionately lower compared to the rents they could command.

More landlords also started to consider houses in multiple occupation which typically generated higher rents and reduced the financial risk associated with void periods when rooms were empty.
For example, a five-bed family home let on a single assured shorthold tenancy might command a monthly rent of £2,000. The same property let to five tenants on separate lease agreements might see each pay monthly rent of £500 – increasing the landlord’s income by 25% to £2,500 a month.

Compliance is more complex

Over the past few years landlords have had to comply with increasingly complex regulations to ensure their properties have a minimum fire safety standard and health and safety measures in place to protect tenants.

HMO ownership has also become more complicated with the introduction of a licensing system governed by local authorities. This has allowed for hundreds of different licensing rules and standards, which vary by local area and are enforced to greater and lesser degrees depending on the council and location.

Consequently, many landlords have outsourced the management of their portfolios to letting and management agencies with the appropriate local knowledge – at a cost.

Energy efficiency

From 2025 all private rented properties let in England and Wales on a new lease must have a minimum energy performance certificate rating of band C or higher. Similar commitments to cut carbon emissions in the private rented sector are in place in Scotland.

Government figures from 2021 show just under half of all domestic homes in England and Wales were EPC band D or below, illustrating the scale of renovation required to raise energy efficiency to hit these targets.

Office for National Statistics analysis meanwhile shows that in England, 42% of assessed homes were rated EPC C or higher, while in Wales, the figure was 37%.

Anecdotal evidence published in March this year by specialist property lending experts, Octane Capital, suggest that around one in three rental properties currently has an EPC rating of C or above.

Estimates vary, but it’s likely that thousands of landlords will face huge bills to insulate rental properties and replace gas heating with electric heat pumps in time for the 2025 deadline. Speculation that some landlords will sell up before then is high.

Outlook for landlords

The National Residential Landlords Association (NRLA) has been critical of government steps to “dampen investment in rental housing” and with the decision to restrict mortgage interest relief to the basic rate of income tax, it means that unlike any other business, landlords are taxed on turnover rather than profits.

It has warned that all the tax changes taken together are fuelling a supply crisis in the sector at a time when demand has reached a record high.

The NRLA is calling on the government to scrap the stamp duty levy on the purchase of additional properties. Ben Beadle, chief executive of the NRLA previously said: “Ministers have been repeatedly warned of the damage that would be caused if they continued to attack the private rented sector.

“The supply crisis is completely counterproductive to the government’s mission to turn renters into homeowners. By suppressing supply whilst demand increases, with rents going up as a result, they continue to make it harder for tenants to save for a home of their own.

“The chancellor needs to wake up to a crisis of the government’s own making, scrap the tax on new homes to rent and review other measures which add to a landlord’s costs.”

At the National Landlord Investment Show in London earlier this month, experts said the outlook for the private rented sector remained positive but indicated how landlords run their portfolios would need to adapt.

The consensus was that landlords hoping to future-proof their portfolios should consider:

• Writing a formal business plan
• Considering your exit plans and inheritance tax planning
• Restructuring your portfolio to include higher yield properties with better energy efficiency
• Working with local council officials to ensure rental properties are compliant with safety standards and licensing requirements
• Building a stronger equity buffer into your portfolio to insulate against inflation and deteriorating economic outlook.
Source: National Landlord Investment Show 2022

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