Take a quick look at the UK buy-to-let market and you might find it tough to understand exactly what it is that makes it so very popular. Dealing with tenants is difficult and boring. House prices have a horrible tendency to go down as well as up (Londoners — ask anyone living in the north of England about this). And rents have long been so low relative to prices that getting a worthwhile net yield is all but impossible after costs.
Given this, you might wonder, why on earth would 14.5 per cent of all mortgage lending in the UK in the third quarter of last year have been to buy-to-let investors? Good question. The answer (as is the case with everything to do with modern money) is that it is all about leverage.
The idea in the mind of the average amateur buy-to-let investor — as I understand it from 15 years of reader emails on the matter — is that as long as you are cash-flow neutral each year (i.e. it costs you nothing) all is well. You’ve put down a deposit. Someone else pays the mortgage via their rent and at the end of 20 years you have a house — for which you have effectively paid nothing but the deposit (assuming you price all the time spent dealing with tenants and admin at nothing). So the two things most investors care about most — yield and capital gains — aren’t particularly relevant. As long as you aren’t forced to sell when the house price is lower than the sum of your deposit, the stamp duty you paid and the remaining mortgage; and as long as the net rent covers the mortgage every month, you’ll win in the end.
But here’s the thing. Once one of those things ceases to be true, the sums change fast. And that’s why anyone thinking of getting into buy-to-let today should think again. In his last two statements, George Osborne has changed those numbers. In the middle of last year he announced that the current system of tax relief for buy-to-let investors, whereby all mortgage interest could be offset against income at the marginal rate and all investors could also automatically offset costs to the value of 10 per cent of their rental income every year, were to be changed.
When the changes are fully implemented (by 2020/21), investors will be able to charge only the costs they actually incur. But more significantly, they will no longer be able to offset interest directly against income. Instead, regardless of their marginal rate of tax, they will receive a tax credit to the value of 20 per cent of their mortgage costs to offset against income tax.
Here’s a quick look at how this works in practice with an example from Brewin Dolphin. A landlord paying tax at 40 per cent has an 80 per cent loan-to-value mortgage. He gets £10,000 in rent and pays £8,000 in interest. On his £2,000 profit he currently pays 40 per cent of £2,000 (£800) leaving him a net gain of £1,200. However, come 2020 his tax bill will be calculated on his turnover minus a 20 per cent tax credit. And 40 per cent of his £10,000 turnover is £4,000. The relief comes to 20 per cent of the interest (£8,000 × 20 per cent = £1,600). The result is a £2,400 tax bill. Add that to his mortgage interest and you will see that his annual profit of £1,200 has turned into an annual loss of £400. Nasty.
Most landlords won’t have mortgages that large but nonetheless you get the point: the changes turn the cash flows around fast. Play with the numbers and you will also see that they can turn 20 per cent taxpayers with property investments into 40 per cent taxpayers without too much difficulty.
All this makes Osborne’s second move — announced in last year’s autumn statement — look particularly unpleasant for wannabe landlords. He’s put up stamp duty for anyone buying a second home — be it a holiday bolthole or a buy-to-let property. Buy after April and your property will cost you three percentage points more in stamp duty than it does now. If you are buying a house at, say, £300,000 that pushes the duty up from £5,000 to £14,000 — a rise of 180 per cent.
The main effect of that will be to reduce the deposit that investors have available when they buy (the more you spend on duty, the less you have for a deposit). So they will end up with a higher loan-to-value — and higher monthly payments — which will make the cash-flow situation even worse than it was likely to be already.
There is a view that none of this matters: a poll last year showed that the vast majority of people still think buy-to-let is a fabulous idea — particularly for retirees. And 60 per cent of landlords told another survey they saw no need to take any action. They might be right. Maybe rents will rise. Maybe the capital gains over the next decade will be so huge that no one will mind the relentless grind of regular annual losses. I don’t buy it. How many people are brave enough or high-income enough to shoulder huge costs on their property (effectively financing their tenants rather than vice versa) in the hope of hitting a capital gains jackpot further down the line? Not as many as the ‘house prices always rise’ brigade like to think.
This is why the National Landlords Association forecasts that half a million buy-to-let flats will hit the market in the next year. I suspect they hope that big numbers like this might make Osborne think again — or at least add grist to the mill of the legal challenge Cherie Booth’s firm is bringing. But I’m certain they won’t. Osborne wants to cool the housing market by making buyers, not sellers, the price drivers. And he wants more youngish people to be able to buy. So, for him, half a million already well-off investors deserting this political hot potato of a market won’t be a shock. It’ll be a thrill.
There is no point in underestimating the ability of politicians and central bankers to get their way on this kind of thing. They may not be much good at the macro stuff (there is no sign that central bankers have a hope in hell of saving the global economy from another meltdown). But changing the dynamics in individual markets? This they can do. They can do it with tax changes like these. And they can do it with the sort of policies that the Bank of England can implement whenever it feels like it (tightening the lending criteria for buy-to-let mortgages, for example).
The Bank of England says its Financial Policy Committee is ready ‘to take action if necessary’. By which I assume they mean ‘if George’s stuff doesn’t work’. So is now a good time to get into buy-to-let? If you want to take on George Osborne and Mark Carney, yes. Otherwise, no.