BIG READ: Tom’s top tips for investing in buy to let

Is buy to let still a good investment? In this article, Tom Entwistle, a residential and commercial landlord since the 1970s and founder of LandlordZONE, draws on his experience to weigh up whether now is a good time to invest.

Is there ever a good time to invest? I have been investing in residential and commercial property for many years and I can’t remember a time when it seemed a good time to buy property.

There’s always something that goes counter, whether that’s the economy, the property market or the finances. But as so often works with investing, it’s usually best to buy when times are bad, when prices are down and others are selling.

Buy to let investing is going through a difficult period, there’s no denying that. What with trouble in the wider economy, a cost of living crisis following severe shocks to the system, including Brexit, Covid and a major war in Europe. We have inflation in double figures and a rise in interest rates / mortgage repayment rates.

The only silver lining as far as landlords are concerned is an economy with full employment and a huge demand for renting.

Still, there’s a lot of apprehension about pending new laws that will significantly alter the balance of power between landlords and tenants – a strengthening of security of tenure not seen in England since the 1970s – a fairer private rented sector.

With rising mortgage rates, a less generous tax regime and the prospect of tightening regulations, for many buy-to-let landlords the numbers are no longer stacking up, and many of them feel the hassle is no longer worth it.

It’s too dramatic to label the buy-to-let private rented sector (PRS) as totally broken. But from an investor’s point of view the days of the casual or accidental landlord are perhaps numbered – investing in rental property can no longer be regarded as passive, armchair investment.

Buy-to-let investing should be considered as a business, and to make money landlords need to treat it as such. Managing a rental property effectively and profitably is increasingly time consuming given all the new regulations to be complied with.

This is particularly the case for the self-managing landlord, but also to some degree, even if a letting agent is appointed to manage. 

Repairs and maintenance are also an issue. Costs are increasing and tax reliefs are less generous than they were. And in some cases serious additional investment will be needed to ensure that a landlord’s properties comply with much more stringent minimum energy efficiency standards MEES, on the way – it involves meeting the energy saving targets the Government has committed to.

A lot of rental properties are ‘old stock’ and need extensive energy efficiency improvements that might be uneconomical when you consider the extra investment needed. Many of those landlords with properties currently rated EPC “D” or less could be looking at conversion costs of £10,000 on the necessary energy efficiency improvements.

Landlords leaving

As a result of all this, an increasing number of landlords have made the decision to either exit the buy-to-let business altogether, or to downsize their portfolios by perhaps selling off their less profitable properties.

Perhaps those in poor locations, or selling off those houses likely to need a big investment to bring them up to the required EPC rating.

Thereby lies a poser: while remaining landlords ponder the best way to adapt to the new regime, those selling up – and many of them are older and due for retirement in any case – are creating an even greater shortage of rentals.

The market is crying out for more rental space in many locations, especially in the bigger cities.

Property agents Savills’ analysis of HMRC capital gains tax (CGT) receipts by Government  data estimates that around 47,000 buy to lets and second homes were sold in the last quarter of 2022, a 21 per cent year-on-year increase.

However, a spokesperson for the National Residential Landlords Association (NRLA) says it has not seen signs of a “mass market exit” in its membership surveys, though a growing number of landlords intend to sell at least one of their properties.

Build-to-rent

There is a perceived threat from the build-to-rent sector by the small-scale private landlord. Large scale developments by corporates, often backed by private equity finance and encouraged by Government policy tax breaks, are based on their assessment of the future potential of the UK rental market – and they see this as very positive.

The threat is real to the small-scale landlord, particularly at the top end of the market where tenants are willing to pay a premium for new build-to-rent rentals with high-end facilities, in major city centres.

This introduces competition in limited locations and especially in the student sector, but the size of these developments is limited overall.

Although the build-to-rent sector has grown very fast, with the British Property Federation claiming 78,000 rental units already completed, and a similar number under construction, that’s relatively small beer compared with the estimated 8.7 million homes rented out by private landlords.

Getting tougher

In comparison to the mortgage rates available just 12 months ago, there’s a world of difference now. For anyone looking to re-mortgage or secure a new mortgage, they will be paying at least three per cent more than they would have last year. That makes it harder to show a profit with an additional cost of perhaps £300 per month for every £100,000 borrowed.

Some landlords are dreading the end of their fixed rate deals, but there are some signs of hope as rates have come down from their peak after the Truss-Kwarteng ‘mini’ Budget last September, and inflation also is predicted to come down sharply by the end of this year.

When interest rates are high, it means that you need either a higher-yielding property – many of which are found in the north – or a lower loan-to-value (LTV) ratio to achieve the same levels of profit.

International agents Hamptons say that on average a basic-rate taxpayer currently needs to purchase a property (when mortgaged) with a seven per cent yield to make any after-tax profit after all expenses, including the mortgage.

Counter to that, is that rental growth still looks strong in many parts of the country, put at around seven per cent per year across the UK and 11 per cent in London. Even so, with high loan-to-value ratios these growth figures will struggle to off-set the mortgage costs.

The financial cost after mortgage rate increases will vary hugely depending on the level of borrowing taken on and the yield on investors’ properties. Landlords in London and the south-east will feel the squeeze most due to higher house prices.

According to Hamptons, average Q4 2022 yields in these regions are five per cent or so, whereas in the north of England they can reach 7.5 to eight per cent.

Mortgage lenders will assess profitability before approving a mortgage deal, so typically they require a 125 per cent minimum interest coverage ratio – that’s the ratio of gross rental income to mortgage interest repayments.

Mortgage free

For those without mortgages and those with the financial resources to buy for cash, buy-to-let investment is still quite attractive for the small-scale landlord, especially for those who are early retired with time on their hands.

Also, with a bit of research and self education, managing buy-to-let tenancies is within the capability of most people, thereby saving one of the biggest costs – the agent’s fees..

Inflation is also a factor here. For those with cash on hand, it’s losing value at an alarming rate – 10 per cent per year – so investing money in property now not only produces an income, it can potentially way exceed inflation in terms of capital growth. This should not be overlooked.

Chief investment analyst at Charles Stanley, Rob Morgan, has said that investors need to regard buy-to-let as a “mini business, rather than a passive hands-off investment”.

Quoted in the Investor’s Chronicle, he argues that buy-to-let can be a good way to supplement a pension for those in their 50s and 60s. These people have typically accumulated a lot of experience and contacts, but still have a significant amount of energy,

When I started investing in property in the late 1970s, just as the short-hold tenancy was introduced, I used an agent to find tenants and manage them for my first property. But I soon realised that I could do a better job of selecting and managing tenants myself. This cut out the agent’s fees, thereby enhancing my profits.

I am also pretty handy with DIY repairs and refurbishments, so I could cut out much of those costs as well. My strategy was to buy run-down properties at knock-down prices, refurbish them to a good standard and then let them.

That strategy is still viable today, and probably always will be, for those who want to reduce risk and also have the practical skills necessary to either do it themselves or project manage a refurbishment.

Higher rate taxpayers

Buy-to-let has become a less tax-efficient investment for higher-rate taxpayers, and those with a mortgage. Full tax relief on mortgage interest was gradually tapered away to a 20 per cent tax reduction between 2017 and 2020. This change pushed some landlords into a higher income tax bracket, unable to claim relief beyond the 20 per cent tax credit.

This has left one option for the higher rate taxpayer wanting to enter the renting market, which is to buy property through a limited company.

There are pros and cons to this and its viability depends on personal circumstances. Investors need expert tax planning advice before going down this route, but certainly letting multiple properties through a limited company can solve many problems for landlords with small portfolios.

It’s a tempting alternative, but it’s important to do your research and fully understand whether incorporating is a good solution for your situation.

If you own a buy-to-let through a limited company it tends to be more tax efficient, especially if you are a higher rate taxpayer. It enables you to use leverage, which means you get more property for your capital investment. You will pay a slightly higher interest rate than a personal buy-to-let mortgage, but these loans are now available.

With a limited company, all mortgage interest payments are tax-deductible, which helps with rising interest rates.  And companies currently are subject to corporation tax on their profits at 19 per cent for profits below £50,000. 

If you pay yourself a wage from your company you will have to pay income tax on this, but you can mix this with dividend withdrawals, making the most of the dividend tax allowance attracting a lower tax rate – the dividend tax allowance is £2,000, reducing to £1,000 from April 2023 and to £500 from April 2024.

Besides the tax advantages, a limited company business gives you increased protection because your personal assets are separated from your business dealings – you will not be held personally liable for any business losses or claims whereas if something were to go seriously wrong while you’re running  your investment business in your own name you would be personally liable.

There are also a few cons to consider. If you have existing buy-to-lets it may not be tax efficient to transfer them into a company as there will be stamp duty and possibly capital gains tax (CGT) to pay.  Also, companies involve quite a bit of documentation and administration which usually means an accountant’s bill of around £1200 per year to administer a company’s affairs.

Mortgages are not as readily available or as competitive for limited companies as is the case for personal ones, and lenders may require a personal guarantee.

Staying the course  

For those landlords who decide to stay in the market, or those new landlords willing to invest, they should prepare themselves for a growing level of regulation and scrutiny. But the property market could soon see a decline in house prices of at least 10 per cent, even more in London, so there could be some attractive buying opportunities on the horizon, especially as some landlords exit the sector.

Not all doom and gloom

Buy-to-let investors with a low loan to value (LTV), those who own their properties outright, or are able to buy new properties for cash, as we’ve said above, will be less impacted by interest rates. Those investors with the cash resources now may be in a position to spot some real bargains – remember, with property or any other investment for that matter, you make most of your money when you buy at a bargain price.

Those landlords who develop good relationships with their tenants and want to hold on to their properties long-term, will see that the current economic storms will pass. It may seem that it’s never a good time to invest if you look at the negatives, but with property you always seem to gain in retrospect. Compounding growth over the years is a very powerful wealth creator.

The market is definitely changing, with increased barriers to entry, but it’s still possible to start a very profitable business in buy-to-let, whatever the popular media might say. Landlords leaving the industry are opening up opportunities for others in what is a really strong market for renting out properties.

You may have to put down more cash to make your investment profitable and your mortgage affordable, especially in areas where values are high.

And remember, there’s a lot to be said for having your rentals close to where you live. Managing property at a huge distance can be a nightmare.

---

For more advice, read Total Landlord’s ultimate guide to property investment.

And if you’ve decided property is the right investment for you, read Seven things to know before investing in a rental property. ‍

This recent episode of The Property Cast – Investing in buy to let in 2023 with Richard Donnell, Executive Director at Zoopla – is also a must listen for anyone interested in housing trends looking to understand the challenges and opportunities of buy to let.

And in this video Q&A for mydeposits, Managing Director of HFIS, Eddie Hooker, and editor of LandlordZONE, Nigel Lewis, debate one of the most pressing questions facing buy to let investors today – should you be looking to buy or sell?

To read more on this topic and access a comprehensive library of guides, articles and podcasts on the private rented sector, visit Total Landlord’s Knowledge Centre.

View Full Article: BIG READ: Tom’s top tips for investing in buy to let