Buy-to-let investors survive challenging times

Keep abreast of market developments and maintain property investment profits

These are challenging times in the buy-to-let property investment world. Property investment news continues to come fast and furiously, and it’s difficult for property investors to stay abreast of developments. As part of your continuing investment education, it’s important to stay up to date with what’s going on in the market. By doing so, you’ll be better able to evolve your property investment strategy and take advantage of the best property investment opportunities.

In this investment news blog, you’ll learn about how government policy could prove to be counterproductive to tenants. You’ll also discover how the buy-to-let mortgage market may be evolving under the new tax regime, and what you can do to make sure both your mortgage and property investment are financially sound.

A brief review of the buy-to-let sector

There’s an enormous disparity between the demand for housing and supply in the UK – at the last count, the difference was a shortfall of around 130,000 homes per year. This excess demand has been a primary factor in the rise in house prices. The average house price in the UK has recently broken ten times average earnings in vast swathes of the country.

As house prices have risen, people have found it increasingly difficult to get on the housing ladder. These people have turned to renting while they save for a deposit. Many others have decided to choose to rent as a lifestyle choice due to various reasons: fed up with homeownership; unwilling to take the plunge after they lost their home because of the Global Financial Crisis and ensuing recession; or simply selling up and using their profits to fund their retirement better.

The private rental sector in the UK is now the largest it has ever been. With predictions for the number of households renting in the UK to rise from the current 5 million to more than 7 million by 2031, the demand that provides such fantastic investment opportunity for property investors is clear.

Property investors have plugged a hole in the market. Local authorities have not maintained enough social housing, and previous government policy (e.g. selling council houses) has shaped today’s current housing environment in the UK.

Why is recent government policy ‘attacking’ the buy-to-let investor?

As the private rental sector has grown, disquiet from renters has also flourished. Complaints about unscrupulous landlords who flout the rules and let properties in an unfit state have increased dramatically. Quite rightly too, in my opinion. Bad landlords tend to get all buy-to-let investors tarred with the same brush. They have no place in our industry.

There is also a groundswell of opinion that buy-to-let landlords are wealthy, money-grabbing b**t**ds who make a property investment and overcharge their tenants. In this kind of environment, the government has taken policy decisions that have pandered to the populace.

A recap of the property investment tax changes

Predominantly, the government has introduced a tax regime that hits buy-to-let investment hard. Measures include:

  • A stamp duty surcharges on additional residential property purchases. It was launched in April and added 3% to the cost of most investment properties bought by buy-to-let investors. This charge has to be paid upfront.
  • A revision of the tax relief on maintenance, scrapping the blanket 10% maintenance charge that can be deducted when calculating taxable rental income.
  • A revision of the way that mortgage interest rate relief is calculated. For higher rate and additional rate taxpayers, the effective tax rate charged will be doubled when the move is fully phased in by 2020.

This tax legislation has been designed by the government to dampen the demand for buy-to-let investment. The idea is that it makes it less profitable to invest in property, and the ‘evil landlord’ purchases will cease to be an upward force on house prices.

The real effect of the buy-to-let tax changes

Unfortunately – mostly for tenants – buy-to-let investors are reacting in the only way they can. They are increasing rental prices to maintain their profits.

The demand for housing isn’t receding. Property prices are still rising faster than wages. The affordability squeeze continues to push people into renting. Property investors are continuing to purchase a buy-to-let investment property. The only difference now is that they need to charge a higher rent to make ends meet. The real loser, of course, is the tenant:

  • The buy-to-let investor makes the same profit as before
  • Government receive more by way of income tax from the buy-to-let investor
  • The tenant pays more in rent (effectively, the tax that the government collects from the buy-to-let investor)

Some estate agents have predicted that the government’s policy, combined with the continuing affordability squeeze, will push rental prices up by around 20%. Meanwhile, the new tax regime and the potential for it to hit property investment profitability in the buy-to-let sector is prompting lenders to reassess their lending criteria.

Rental cover minimums are being pushed higher

Banks and other lenders have started to react to the new tax regime, fearing the impact on buy-to-let investors. More tax and lower profits make keeping up the mortgage payments more difficult. To protect themselves, lenders are asking for higher rental cover.

For example, both Barclays increased its rental cover minimum to 135% – the rent has to be 35% higher than the mortgage repayments. The Mortgage Works (a subsidiary of Nationwide) raised its rental cover requirement to 145%. You can expect more lenders to follow suit.

However, in a groundbreaking change, another lender has signalled that an even tougher lending regime could be on its way.

Buy-to-let mortgages to be assessed on ‘individual circumstances’

Birmingham Midshires (a Lloyds Bank subsidiary) has recently changed its lending terms for buy-to-let mortgages. Like many other lenders, it has increased the rental cover that buy-to-let investors need to evidence to be accepted for a mortgage. However, in a first for the UK buy-to-let mortgage market, it is upping this requirement, not across the board, but for borrowers who would be taken into a higher or additional rate tax band – those that stand to be penalised by the mortgage tax relief change.

This makes Birmingham Midshires the first to operate such a system, where the rental cover required depends upon the buy-to-let investor’s tax band. It will make its mortgages much more targeted to the individual, but also probably increase the amount of paperwork and red tape needed to pass its requirements. These new rules will take effect from the ‘end of the year’.

Why are lenders increasing rental cover requirements?

Buy-to-let mortgage lenders are reacting to the new tax rules and pressure from the Bank of England, who wants to ensure financial companies don’t overstretch themselves with unsustainable mortgage lending – the kind that did so much damage and was a chief cause of the Global Financial Crisis of 2008/9.

So, lenders are changing their buy-to-let lending rules partly to come into line with pressure from the regulatory bodies, but also for self-protection.

What are the government and regulators hoping to achieve?

The new tax rules are clearly designed to make it less financially viable for buy-to-let investment. Policy makers believe that rents will not rise too much in response, being restricted by current prevailing rents and market competition.

What strategies can you employ to keep your buy-to-let investment profits on track?

There are several strategies you can use to make certain that your property investment profits remain intact. Here are five of them, though which you use will depend upon your individual circumstances and investment goals:

1.      Use a mortgage broker

Now more than ever you should consider taking advice on mortgage choice. Use a mortgage broker who has particular experience and expertise in the buy-to-let market. They’ll be able to advise you on rates, conditions, other clauses, fees and charges, and deposits.

2.      Pay a larger deposit

Paying a larger deposit serves some purposes and gives you some benefits.

Among these is that the fact you’re prepared to put down more of your money, which gives the lender more confidence in that you’ve done your homework and understand the risks and rewards. It usually translates into a lower interest rate – so you get the benefit of lower mortgage payments at a reduced rate of interest. Over a number of years, this can make a big difference.

As your mortgage payments are lower, that rental cover number is easier to achieve, too.

3.      Work through your cash flow projections diligently

Ensure that you are conservative with your cash flow projections. If you underestimate rental income and overestimate costs, you’ll stay on the right side of caution. We always recommend stress testing your cash flow by allowing for an increase in interest rates – and this is something that the Prudential Regulation Authority (PRA) included in its proposals to lenders in March 2016 (affordability checks based on a ‘stressed’ interest rate of 5.5%).

4.      Charge a higher rent

Do your research right, and make sure that you are charging the right rent. Watch the market carefully, and ensure that you have rental review clauses in the tenancy agreement that enable you to raise the rent. Remember that you’ve bought the investment property to pay a return.

You may have to accept a period of negative cash flow, but remember that other buy-to-let investors will be in the same boat as you and will also want to increase rents to retain their profit margins. You stay competitive by staying in business and offering your buy-to-let investment property at the right rent – which, over time, will increase.

5.      Consider how you structure your investment

While avoidance of tax should never be the overriding reason for property investment, consider taking advice from a tax specialist. They’ll be able to discuss how to structure your buy-to-let purchase for maximum tax benefit: for example, there may be some tax advantages by setting up a limited company for investing in property.

Contact one of our team on +44 (0)207 923 6100 to talk through your property investment options and the strategies you can employ to help maintain your rental income profits.

Live with passion

Brett Alegre-Wood

About the Author

Brett has over 20 years experience in all facets of property, he owns various companies centred around property and is the driving force behind the education and training at Gladfish. His companies have sold over £850 million in UK and London property and he manages over 1200 properties through his estate agency chain. Today he shares his time between UK, Australia and Singapore. He is married to Arlene and together they have 4 kids.

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