As an investment adviser, I am struck by the number of clients who ask: “Should I invest in a buy-to-let property?”
Given my job, you would probably expect me to be biased against property investments.
Certainly, my stock answer for high-earning clients used to be not to go out and buy an investment property. This is because pensions have been a much more tax efficient way to save — higher-rate tax relief on the way in, tax-free investment growth, and the promise of taking a quarter of your pot tax free on the way out. Lovely.
But if they had a partner who was a lower or basic rate taxpayer, my answer would be maybe to buy one property. But only one, so the tax did not push them into a higher tax bracket. Also, multiple properties are a hassle to look after (an investment manager doesn’t phone you up when their dishwasher is broken).
The income stream from a property should give a tax efficient income now and in retirement. You can also “gear up” and borrow against your asset, and the tenants will pay down your mortgage over the years.
This sounds like the perfect investment, almost too good to be true. Well, previous chancellors thought so too, and the resulting tinkering with the system has created a property tax nightmare.
When investing in property these days then, you should ideally be doing so for two reasons: for the yield and for tax efficiency. Without either of these, you are simply hoping that the house increases in value.
I have a lot of clients who have fallen into the property tax trap because they forgot these two principles.
Let’s say they bought a buy-to-let years ago. It’s worth a lot of money now, but the rental yield is terrible and is taxed at their highest marginal rate. If they sell now, most of the sale value will be subject to 28 per cent capital gains tax (property CGT is 8 per cent higher than CGT on investments). They will also be worried about inheritance tax.
So the nightmare is they sell the house and lose about 30 per cent of the value once estate agent fees are taken into consideration. But if they were unlucky enough to die the day after completion, this could trigger a 40 per cent inheritance tax liability on the remaining 70 per cent of the sale cash.
Property can also be a pain to gift. You can’t give your children 300 bricks or half a bathroom. But you can give small gifts to your beneficiaries with cash or an investment portfolio.
Investment property is becoming a more expensive investment to hold. From April, landlords will only be able to offset basic rate tax relief on their mortgage cost. The current direction of travel would indicate that this tax relief may go altogether — a scary thought ahead of the new chancellor’s first Budget on March 11.
Furthermore, buyers now have to pay 3 per cent additional stamp duty on a second property.
Landlords will additionally pay higher deposits, fees and interest rates on a buy-to-let mortgage as this type of lending is considered higher risk. So in today’s market, you will need price growth of about 10 per cent just to get back to square one. The rental yield means you are perhaps, but often not, covering the mortgage costs (by my reckoning, you will be doing well to get a yield of 2 per cent on a London property). And remember — you are not making a yield on your deposit.
Basically, a landlord entering the market today will probably be paying for someone to live in their house as they dream of a capital gain. Yet if this ever comes, they would not be able to crystallise it without paying 28 per cent tax — and that’s assuming they won’t be hit by other tax increases in future.
Nonetheless, I bought a second property anyway.
I thought that as I am now getting to be an old man, I would diversify. I have a share in the firm I work for, and I work in the investment industry, so I have that risk on top of an average investor’s normal equity risk.
Merryn Somerset Webb has very strong views on my purchase, as I bought a basement flat in Edinburgh, her stamping ground. Most of my family live there and my firm has an office there. So I use it for fun, for work and I rent it out on a short-term let on various apps and websites.
This means I benefit from international tourism. In fact, last summer I had one guest all the way from Los Angeles who complained the flat was too hot! Luckily, my homeland didn’t let me down: it started to rain as I was buying him a fan. Good old dreich Scottish weather.
I am making money (the yield on this property, net of fees is about 4.2 per cent). But although my family love staying there, not all of my friends approve of my investment.
One had a two-hour rant at me for depriving the people of Edinburgh a place to live. But if I didn’t buy the flat, then it’s likely another landlord would have. And having a short-term furnished holiday let (rather than a buy-to-let) suits our family circumstances.
There are very important tax differences between the two. In the UK, to qualify as the former, your property must be available as furnished holiday accommodation letting for at least 210 days in the year. No, you staying in it “on holiday” does not count. You cannot rent it to the same person for more than 31 days.
You are, however, able to offset the mortgage costs against the taxable gain each year, as well as offset all costs such as furniture. Additionally, when you sell, it qualifies for entrepreneurs’ relief, rollover relief and holdover relief (please tweet me if you want these explained, I will run out of words otherwise).
But, excitingly, profits count as earnings for pension purposes — so you can claw back some of the tax bill with a pension contribution.
My first year of ownership threw up one first world problem — the huge success of the Edinburgh Festival means I cannot afford to stay in my own flat in August.
Overall, the yield is better, there are more tax advantages and we get to stay there.
No investment is without risk, and I have gone into this fully aware that politicians could try to restrict short-term holiday lets through the planning process in future. But by explaining honestly how I’ve weighed it all up, I hope you can see for yourselves how much is at stake if you’re deciding whether to invest in a second property.
Michael Martin is private client manager with Seven Investment Management (7IM). The views expressed are personal. Twitter: @7IM_MichaelM