Pay less tax and make a higher return on your investment
Cash is king. That’s one of the lessons that’s drummed into us from a very early age. If you have the cash to make a deal now, a seller is likely to take a lower offer. In most things, I would say this is true, but buy-to-let property investing may be the exception that proves the rule.
In this post I’m going to show you why being a property investor with financing in place could be better than being an all-cash property investor.
Cash buyers get great deals − usually
Even in the world of investing, cash speaks very loudly. Take Warren Buffett, for example. One of the world’s most respected (and wealthiest) investors, his fund, Berkshire Hathaway, has returned an average of 19% per year. It also sits on a pile of cash, which it uses to take advantage of bad markets. Berkshire Hathaway invests in companies when Buffett thinks they’re undervalued, and can strike great deals because of the cash it’s sitting on.
It’s a little different for property investors. It’s how property investors negotiate below market value property deals that makes the big difference here, and not the amount of cash you’ve got. With a buy-to-let mortgage agreed, you’ll be a pseudo cash buyer anyway. The fact that you’ve got cash in your pocket to do a deal may get you a little extra discount to the house price you’ve been quoted, but it will probably be less than you think.
More capital gains tax to pay as a cash buyer
When you sell investment properties, you’ll also be liable to capital gains tax on every penny profit over the CGT threshold. For 2016/17 this is £11,100. A bigger discount for cash will give you a bigger profit when you sell, but you could pay up to 28% capital gains tax on that extra profit.
But this isn’t the only buy-to-let tax implication you need to take into account when structuring your property investment.
Income tax and the property investor
When you invest in a buy-to-let property for the rental income, if you buy all cash then you won’t have mortgage payments to cut into your rent. But mortgage interest relief is one of your investment property's major tax reducing deductibles that you can benefit from as a property investor.
If the rental income you receive takes your total income into a higher tax bracket, you’ll end up paying income tax at either 40% or 45%.
If you finance the property purchase with a mortgage instead of money and use an interest-only, buy-to-let mortgage to do so, you’ll be taking advantage of the mortgage interest relief you can claim to reduce the rental income you receive as a landlord. In other words, the costs of your mortgage interest become a tax efficiency tool.
Taking advantage of property leveraging
If you use your cash savings to invest in property, you’ll get a lesser return on your investment!
I know that sounds daft, but it’s true. When you borrow money to invest in a buy-to-let property, you’ll be making a profit on money you don’t have.
If you buy a house for £200,000 and rent it out at, say, a 7% yield, you’ll earn £14,000 in a year before costs. So let’s say the costs of professional property management, maintenance, repairs and the like are a total of £3,000. You’re left with £11,000, or 5.5% return on investment (before you pay income tax).
If you structured the same deal using £50,000 of your money as a deposit, you’d still receive the £14,000 gross rental income. Now, your costs are £3,000 plus, say, £6,750 in mortgage interest (at 4.5%). Your net income before tax is £4,250 – or return on investment of 8.5%.
Instead of using all your cash to buy just one property, you could buy four properties with the same financing structure and receive an annual income after costs, but before expenses of £17,000 – that’s £6,000 more than buying a single property in an all-cash deal.
This ability to use other people’s money to make higher returns is called ‘Leveraging’, and is of the seven reasons why property investing beats all other investments.
Investing with a mortgage reduces buy-to-let tax implications
In summary, by investing in property with a buy-to-let mortgage, you’ll benefit from:
- using someone else’s money to make a profit on your investment;
- reducing the income tax you may have to pay on your rental income; and
- the ability to negotiate a price below market value as a pseudo cash buyer.
The return on your investment will be higher, and you’ll have extra cash to either invest elsewhere or in other properties or simply keep as a contingency fund.
Get in touch with Gladfish today on +44 207 923 6100 and we’ll be happy to talk about how the right financing structure can power your buy-to-let profits. We’ve also got great connections with some of the best buy-to-let mortgage brokers in the business.