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February 12, 2019
Buy to let versus property bonds
For decades, investors have believed that property is one of the safest places they can put their money – safer than a pension (source:FT). But, as the government has increased the tax that landlords have to pay at the same time as there is uncertainty on the UK’s economic future and what it might be after the country leaves the European Union, is there a better and quick way to making money from property than buying houses to rent them out?
In this article, Lisa Kinghorn examines the pros and cons of buy to let and property bonds.
Pros and cons of buy to let
Less favourable tax treatment
The buy-to-let market has offered fantastic opportunities for landlords over the years. A combination of low interest rates and high tenant demand, along with favourable tax treatment, has made rental property the go-to commodity for new and experienced investors for a long time. People will always need somewhere to live so low levels of new house building and a rapidly rising population has meant that, for a long time, landlords have had a captive market.
Tax relief schemes focused primarily around the treatment of mortgage interest payments which, until recently, allowed landlords who were higher and additional rate taxpayers to claim back in full the interest on their mortgage payments.
However, the glory years of the buy-to-let landlord came to an end in 2015 when the then Chancellor, George Osborne, announced plans that would completely change the way the system worked.
From April 2020, you’ll no longer be able to take mortgage interest costs from the income generated by your property when you’re calculating profitability. What replaces it instead is a basic rate reduction on mortgage interest from your income tax liability. In addition, the “wear and tear” allowance of 10% was also scrapped.
Although the idea of buying to let is no longer as obviously attractive to many as it was a few years ago, there are still lots of opportunities to be had from getting into the market. It’s just a question of doing your research and understanding the potential financial and managerial pitfalls of renting out property to tenants.
“Void” months – when no-one is renting out your property
“Void” months are a financial hazard for any landlord.
When properties are sitting empty, all they’re doing is wasting landlords’ money. The mortgage is not being met plus council tax and other bills become the landlord’s responsibility again.
Mortgage companies don’t care whether a property is being lived in or not – all that matters to them is that the monthly repayments are made on time. For more information on how to protect yourself against rental voids, we like this article from Property Hawk.
Improvements made to the house can only be claimed back when you sell
If you buy a property to rent out to someone else, you will more than likely have to spend money on the property before it’s ready for tenants to move in. Improving the fixtures and fittings will make your property more attractive to tenants but, because of the way the tax system operates, this is considered “capital” spending which you can only claim back the expenses on when you sell the property.
Landlord taxation is never straightforward and the “capital versus revenue” distinction has caught many landlords out. This article from Karl Watts of Sunny Accountants explains it in plain English, and can help clear up any grey areas.
Very high cost of entry
Finding funds for stamp duty and for the initial deposit on a property has always been difficult for landlords. According to Simply Business, the standard buy-to-let mortgage deposit is 25% these days. Compared to the deals some mortgage companies are offering first time home-owners, it’s easy to see why so many wannabe landlords are struggling.
Standard home buyers pay less than buy-to-let landlords on stamp duty – landlords must find an extra 3% of the value of a property if your intention is to rent out.
Buy-to-let landlords need to have a significant sum of money behind them before they can start out in the business.
In January 2019, the average house price is £226,906. A 25% deposit will require £56,276.50 in available funds. Add that to the £8,845 stamp duty and that’s a total expenditure of £67,000 before any renovations you then need to make, let alone start turning money over by finding a tenant.
Somebody else is responsible for mortgage payments
If you’re considering getting into the buy to let market, there are two main ways in which you can make money. The goal is to profit each month from the rental fees you charge and, when the time comes to sell, from the rise in the value of your property during the time you owned it.
Landlords who are fortunate enough to find a long term tenant who pays on time and looks after the property are able to cover their mortgage, insurance, maintenance and letting fees over time. If the rental rate is priced right, a landlord will show a marginal profit each month.
The yield you benefit from will vary according to the kind of property you invest in and the area in which your property is situated. You can find out more about property yields and which are the best areas to invest in on the Totally Money buy-to-let yield map.
Hold onto your property for long enough and the tenants will cover all your costs completely leaving you with a valuable asset. But be prepared because this is a very long-term hold.
Value of the property likely to be higher as time goes on
The UK economy can be difficult to predict but what we do know is that people will always need homes and that Britain has not built enough of them nearly every year for 30 or more years despite a fast-growing population.
In our country, there’s also a strong desire for people to own properties rather than rent. Both of those factor should drive prices upwards and the statistics seem to back that argument up. Back in 1998, the average house in the UK cost £62,770 770 (source: BBC News). In just over 20 years that figure has tripled with the average property now valued at £226,906 (source: HM Government).
As with buying shares on the stock exchange, timing is everything. Buy during a lull and sell during a boom and a landlord will likely enjoy a substantial capital gain.
Pros and cons of property bonds
Short-term returns compared to hands-on buy-to-let
Property bonds tend to be issued for just one project at a time and, once that project is complete, you’re paid back your initial investment plus interest once the bond matures. The average maturity rate for a property bond is between one and five years.
The average property bonds delivers a fixed return in the same way that a savings account or a cash ISA from your bank does.
The really great thing about property bonds is that they offer a far higher rate of interest than you can expect from a cash ISA. Cash ISAs can pay out as little as 1% per annum. You will get better rates on cash ISAs where you agree to tie you in to a scheme for an agreed amount of time – usually between six months and two years. However, if you want to withdraw money early, you’ll have to pay a penalty fee.
Property bonds, on the other hand, deliver rates of between five and twelve percent. These levels of interest can be offered on property bond schemes because successful delivery of the business plan underpinning a property bond issuance produces a generous net profit.
Not as easy to sell as other types of investment
Property bonds are often transferable but not always. If the property developer does allow you to transfer your bonds to someone else, there’s no guarantee that you’ll find a quick buyer. It’s also important to be aware that the buyer may ask for a discount on the bonds and you may be required to pay transfer and admin fees to your IFISA manager if you wish to get out early.
What’s right for you?
Before investing in anything, including buy-to-let properties and property bonds, there are some important questions to ask yourself are:
- – Do I understand the numbers and how it all works?
- – Am I happy with not being able to access the funds immediately?
- – Am I clear on the risks?
- – If I have an existing portfolio, is it too focused in one area? Should I consider a different investment opportunity to help me rebalance the risks and improve my long-term yields?
Whatever route you take, be sure to work with people you trust and don’t take any uninformed risks.
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To learn more about the Azurite investment, please download our brochure here.