29th May 2019
I have had a number of landlords decide to sell their investment properties recently. Many of these landlords have chosen to sell following the effects of the changes to mortgage interest relief on their loans, resulting in less profit from their properties, and higher tax bills.
Pre-2016 landlords could deduct 100% of their loan on a buy-to-let against tax. From 2016/17 Government has started to phase this relief down to a maximum of 20% by 2020/2021. The effect on a landlord with a high loan-to-value ratio mortgage and employed or self-employed earnings that already mean they are 40% tax payers, these tax changes will leave them considerably worse off.
An example would be a landlord with a £150,000 property producing £700 pcm (£8,400 per annum) in rent, on which they have an 80% loan-to-value mortgage i.e. £120,000. Let’s assume for simplicity the mortgage is interest only and the rate is 4.5%. The mortgage is costing £5,400 per annum (£450 pcm). The management costs and maintenance average out at say £2,000 per annum.
Tax @40% £400
Net Profit After tax £600
One would query the logic of buying such an investment for such a poor return. This is actually typical of a ‘reluctant landlord’ or an ‘accidental landlord’; someone who is letting their former home after relocating with work, but possibly considering a return to the property at some time in the future.
Less costs £2,000
Tax @40% £2,560
Less 20% of mortgage £1,080
Tax due £1,480
Net profit after tax (£ 480) £8,400 less (£2,000 + £5,400 + £1,480) = -£480
The phasing-out of tax relief is going to result in the property ‘running at a loss’. The profit of £600 has suddenly turned into a loss of £480. The landlord is now subsidising their property from earned income. Unless the property is viewed as an alternative to a long-term pension, it wouldn’t be worth holding onto this property, and a sale would be sensible.
For basic rate tax payers the result is not quite as painful. What would have been an £800 profit after tax is reduced to £395. Nontheless, it remains profitable i.e. the property is ‘washing its face’ so long as no major repairs are needed?
The situation is slightly different where the landlord has a much smaller loan. 50% loan to value on the same property would show:
Less costs £2,000
Less mortgage £3,375
Tax due @40% £1,210
Net Profit after tax £1,815
Less costs £2,000
Tax @40% (not due) £2,560
Less 20% of
mortgage interest £675
Tax due £1,885
Net profit after tax £1,140
For basic rate tax payers these changes have no effect. A basic rate tax payer was benefiting from 20% tax relief in the first place. They still have that benefit. In the latter example, a basic rate tax payer would still be making a profit of £2,420, after tax.
For higher income earners, analysing their investment property returns would be wise. I am still a strong advocate of property being a good long-term investment. However, not at any cost. A good landlord needs to be able to maintain their property. They have a duty of care to their tenants and the recent Homes (Fit For Human Habitation) Act 2018 puts an even greater burden on to landlords to ensure they continually reinvest in the fabric of their property.
Capital appreciation of property should never be the sole determinant of why to buy an investment property. My analysis of house price growth in north Leeds shows that in any 10-year period from 1950 property values have increased e.g. 1997 to 2007. The 5-year periods have seen some with increases and some with decreases e.g. 2008 to 2013. It is no doubt that capital growth is the underlying objective for the majority of landlords, but the property must be self-funding in the meantime.
If you would like our opinion on the long-term prospects for your residential investment property please contact us. Angie Wright, Michael Davies and I have over 70 years of experience between us. We’d be delighted to help you.