The UK Buy-to-Let Property Crisis Explained

over the last six months I have had calls from multiple clients saying that they are done with buy to let investing these are people that have been investing in property for decades but have decided that it's just not worth it anymore and they want to sell over the last 30 years buy toled investing has been a way for middle class people to invest their money and create an income for themselves in retirement for many it seemed to be the only way to invest as they don't trust pensions or the stock market but over the last few years the government has made a series of changes to legislation that along with higher interest rates has brought the buy to Let's Market to its needs so I'm going to show you the cash flows of one of my clients rental properties from 2017 and then I'm going to show you what it looks like now if you're a buy to learn investor I imagine you're all too familiar with what you're about to see but if you're not well this is going to shock you because it certainly shocked me and the ramifications of this for investors but more importantly The Wider rental and housing market could be huge hello and welcome back to the channel if you're new here hi my name is James I I am a financial planner and this is a place where you can learn about saving money investing and over time building yourself into a position of financial Independence I stress this because I know buy toled investing is a highly divisive topic you have buy toled investors on one side and then you have renters on the other and arguably if things are bad for investors then they are even worse for those that are renting but given that this channel is about investing I want to show you what is going on from the perspective of investors this is the list of changes that the government has made over the last 15 years that is made by toled investing much less attractive our journey starts in 2017. so by that point the government had already removed indexation relief for capital gains increased stamp Duty by three percent and increase the rates of cgt on property to 18 and 28 and I'm going to talk through the rest of these as we go through this the property we're looking at is a one bedroom flat in Oxford which my clients own in their personal name rather than through a company in 2017 the value of the property was a hundred and ninety thousand pounds and the annual rent was eleven thousand one hundred pounds a year or 925 pounds per month which gives a rental yield of 5.84 the average UK rental yield is about 4.75 so this yield is certainly higher than you might find in London or other Southern areas but not as high as you might find in the north for costs we have letting agents fees gas safety certificates service charge ground rent and insurance and maintenance leaving a net income after direct costs of 8 650 pounds which is a 4.55 yield which is not bad seeing as this property may also see capital appreciation of three to four percent per year on top of this this is the return that you would get if you had no mortgage on the property but this property had a 125 000 pound interest only mortgage at a rate of 3.5 so after all costs they were left with 4 275 pounds and given that they have 65 000 pounds of their own Capital tied up in this property that's a return on capital of six point five eight percent per year plus they're going to get potential Capital Growth on top of this too which shows you why investors like to use leverage to boost their returns it's these headline figures that make property investing seem so attractive but what they don't show is the risks because there will be years where appliances need to be replaced or boilers need to be fixed where there's leaks or damage that needs more substantial repairs then you'll need to redecorate every five years replace the carpet every eight you'll need a full electrical inspection every five years then of course there's the risk that if you are without a tenant for a month or you get a bad tenant that refuses to pay rent or damages the place then you could see yourself making a loss for a long period of time all Investments have risk which is why you should never assess an investment based on its headline return You always need to put that into the context of the risks that are being taken and generally the higher the yield or the return on an investment the higher the risk and when you add in leverage to the mix all of those risks just get compounded as you're about to see so let's look at how things have changed between 2017 and now the value of the property has increased to 250 000 pounds a 31 increase rent has gone up to 14 160 pounds or 27.5 increase to help you put these figures into perspective inflation is up by about 27 over this period so both the value of the property and its rent have risen roughly in line with inflation for costs letting agency fees are up 27 the same as rent gas safety certificate up 55 got service charge and ground rent up 103 and then we've got maintenance up 42 which brings total direct costs to 3986 pounds or an overall increase of 63 percent tracking well ahead of inflation net income after direct costs has increased to 10 174 pounds but but because the value of the home has increased to 250k the yield is down slightly at 4.07 the mortgage is the same value but because they refix their mortgage the rate has actually gone down to 2.2 percent so with total mortgage interest of 2 750 pounds the net income is much higher than in 2017. at 7424 pounds which sounds great but it's not in 2017 the owners were higher rate taxpayers so to calculate their 2017 tax we would simply subtract 40 from their profit leaving them with an after-tax income of 2565 pounds or a 3.95 net of tax return on Capital if we go through the same process but with the 2023 figures they would end up with five thousand pounds after tax or a 3.5 net of tax return on Capital however since 2017 the government has changed the way that mortgage interest Works in this calculation in 2023 if you are a buy to let investor that owns the property in your personal name you can no longer deduct mortgage interest as a cost of doing business which means that their taxable income is now much much larger however the government has introduced a 20 tax credit for mortgage interest which means that you can get 20 of your mortgage interest off your tax bill the idea behind this is that if you are a basic rate taxpayer and all of this taxable income still Falls within the basic rate band then you would be no worse off however because your taxable income is now much larger and income tax bans have been frozen for the last four years it's now much more likely that investors will be pushed into these higher tax bans given that the owners are already higher rate taxpayers the result is that they have to pay 20 of their mortgage interest in additional tax so in a way this is a tax on mortgage interest so when interest rates are low the effect is muted but when interest rates are high it makes a situation much much worse this has been a hugely divisive policy for a number of reasons firstly well obviously nobody likes to pay more in tax but this just doesn't seem fair because other businesses like a car rental business that uses Finance to buy the cars or a manufacturing business that borrows money to purchase Machinery can offset the interest that they pay against their income it's just the cost of doing business this and then they only have to pay tax on their profit even if you run a holiday rental business so you run an Airbnb you can still do this but for some reason the government has decided that buy to let investors that are providing rental accommodation for long-term lets can't what's even stranger is that this only applies to those that owned by Select Property in their personal name if you own the property inside a limited company it doesn't apply putting property inside a limited company has only become popular recently and is generally only cost effective if you have three or more properties so this policy is specifically trying to make it harder for smaller investors and those that have been investing for a long time and just built up multiple properties in their own name but as we can see here even with the higher taxation this is still a fairly profitable investment well right now it is but the fixed rate on their mortgage is due to expire at the start of 2024. so they're currently looking to get a new fixed rate offer at the time of recording the average two-year fixed for a buy to let mortgage is about 6.5 percent or six percent for a five-year fixed so if their mortgage rate triples to 6.5 percent this is what's going to happen to their cash flows their income before tax is going to drop from 7 000 to 400 pounds to two thousand pounds under the old rules they would then be taxed on this profit at 40 leaving them with 1229 pounds after tax but with the new rules they are don't end up having to pay more in tax than the income that they have made imagine that going out to work for a day and then the tax man is sending you a tax bill for more money than you earn that day what's more is that this property has a relatively low loan to value of 50 whilst many buy to lets have mortgages of up to 75 percent if that was the case with this property they would be losing 300 pounds per month or that's a minus 5.8 percent return on Capital per year clearly this is not a good situation to be in so what can they do about it well if you've never been a landlord you're probably thinking that they can just put the rents up right but that is not how the rental market works or any market for that matter the current tenant is due to leave in March 2024 so the rent is fixed until then and when they do leave the owner will go to their letting agent who will put the property on the market for whatever the going rate is for properties in the area they could try and put it on for slightly higher than the market rate but if it's too high they're not going to get many viewings and they could find themselves without a tenant which is a big risk given that this property could be losing a thousand pounds per month yes if the aggregate costs across all landlords are increasing we would expect rents to increase too but given that lots of landlords don't have a mortgage own their properties inside limited companies and are remortgaging at different times Market rates are unlikely to rise in line with your costs so for the most part landlords just have to accept whatever rate the market is offering at the time with those market prices set by supply and demand which is a point we'll come back to later so what else could they do what about owning this Insider limited company with that you would get a better tax treatment but the interest rate on mortgages held by limited companies are generally one percent higher which would leave you with a measly 0.64 percent pre-tax return on Capital with that profit likely being eaten up by the higher Administration costs of running a limited company so no that's not going to work meaning that they may have no choice but to sell and if they can get 250k for it well that's not all bad given that they've received pretty good returns up to this point but who's going to want to buy this property at that price certainly not another investor because if they bought it with a mortgage then they would be in exactly the same situation and if they bought it with cash well who's going to want to invest in a risky buy to let that yields four percent per year when you can get five percent on a risk-free hassle-free Government Bond think about that given that you can now get five percent interest on cash in the bank how large a yield would you require to buy this property think about all of the risks involved and all the hassle that you're going to have to put up with what would you require nine percent ten percent at least so for this buy to let to become an attractive investment either rent has to double or the value of the property has to Fall by 50 and I don't think either of those things are going to happen this is the problem that is happening with buy to let properties all across the country so what does this mean for the rental market as a whole of the UK's 23.7 million households 4.4 million of them are private rentals so roughly 20 of UK housing stock is by two lats with interest rates where they are the vast majority of these are no longer attractive when you compare them with other Investments that you could make especially when you consider the fact that the government has a bunch of other policies lined up that are going to make buy to let even worse so it's likely we're going to see a lot of landlords exit the market which some people think is a good thing because they are then freeing up housing supply for people that want to buy it and live in it themselves now I'm not an economist but I don't think it's that simple rents are set by supply and demand if the supply of rental properties goes up or demand goes down then all else being equal rents should fall if this Supply goes down or demand goes up then rents should rise let's say that my clients sell their one bedroom flat to the person that is currently renting from them so we've taken one renter out of the market and we've also taken one rental property out of the market supply and demand are balanced so rents remain the same in theory but my clients also have another property which is a six bedroom student let which is also going to become unviable when their mortgage rate goes up next year so let's say that they then sell that property to a family of four that were previously renting we've removed four people from the rental market but we've lost the supply for six and actually hang on instead of selling that one bed flat to a renter they could just turn it into an Airbnb because not only might they get enough income to sustain their property but the government's tax on mortgage interest will no longer apply so if all across the country landlords are being forced out of long-term buy to lets in this way that is only going to reduce Supply and increase demand pushing rental prices higher and higher so do you see how these government policies are actually making the situation worse for everyone after hearing all this you probably think that I sympathize with landlords but for the most part I don't because landlords are investors and like all investors they should be comfortable with the risks of the Investments they make they should expect there to be times when the market will turn against them when interest rates will rise or prices will fall and they will lose money especially if you're using high amounts of Leverage and although it sucks when this happens it should not be unexpected and if it is then you've clearly not done your research but what I do have sympathy for is when people are working hard to save and invest money for their retirements and the government keeps coming in and moving the goal posts as I said at the beginning of this video many people see investing in property as the only way to build wealth and invest for their retirements but the government has decided to tax retail investors out of the market and it's only going to get worse I appreciate that this video is very different from my other ones because normally I bring your problems and then I give you Solutions but unfortunately I've got no solutions to give you because I don't actually know all that much about property I'm not a big property investor and I certainly don't know anything about setting government policy but the only takeaway I can give you is that it is now so important that alongside property you make use of the other generous tax efficient tools that are available for Building Wealth and if you want to learn what they are and how you can use them well that is what this channel is all about

Channel: James Shack

Views: 282,593

Keywords: property investing, buy to let, buy-to-let, Uk House Price Crash, House prices, Property crash

Id: NtVk3ERt66w

Length: 16min 41sec (1001 seconds)

Published: Sun Aug 06 2023