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The buy-to-let boom is unlikely to quieten

Thomas Clarke - Head of Bridging

April 15, 2016

Buy-to-let landlords have had a tough time of it of late, suffering a number of disadvantageous tax changes which have reduced the apparent appeal of residential rentals as an investment vehicle.


On 1st April, a new stamp duty land tax surcharge targeted at prospective private landlords was imposed, adding a hefty 3% to the up-front tax bill for those buying investment properties. A stampede of buy-to-let investors entering the market in an attempt to avoid the charge has exacerbated the problem by inflating house prices to a fresh record in the process.


In addition, from 6th April next year, arrangements permitting landlords to offset all of their mortgage interest against rental income are to be phased out, with full implementation by 2020. Tax relief will, in future, be a flat rate of 20% – landlords who pay basic rate tax would see no change, but those on higher incomes will find themselves hit hard. Essentially, landlords are being taxed on revenue rather than profit – the higher the rate of mortgage interest paid, the more one would feel the pinch.


Data provided by Property Partner, a ‘crowdfunding’ website, cover more than 100 of Britain’s largest towns and cities and show that, at present, landlords’ average net profit is calculated at £3,419. This would fall to £2,555 by 2020 as a result of the mortgage interest tax changes, even if mortgage rates remained at current levels. Fortunately, interest rates are predicted to remain at their record lows until 2019, according to recent forecasts, with Mark Carney, the Governor of the Bank of England, saying last month that an “unforgiving” global environment was likely to keep rates at a record low of 0.5pc for longer than previously expected.

Hundreds of thousands of property investors are likely to be affected by the tax relief change. Smith & Williamson has calculated that higher-rate taxpayer landlords (who own about 40% of market-rented UK housing) whose mortgage interest is 75% or more of their rental income, net of other expenses, will see all of their returns wiped out by 2020. So mortgage costs above 75% of rental income will mean the buy‑to‑let investments become loss-making. For additional-rate (45pc) taxpayers, the threshold at which their investment returns are wiped out by the tax is when mortgage costs reach 68pc of rental income. Some current basic-rate taxpayers will also be hit, because the change will push them into the higher-rate tax bracket.

Here’s a quick look at how this works in practice with an example. A landlord paying tax at 40% has an 80% 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% 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% tax credit. 40% of his £10,000 turnover is £4,000. The relief comes to 20% 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 his annual profit of £1,200 has turned into an annual loss of £400.


Furthermore, a generous 10% annual allowance for ‘wear and tear’ on furnished rental properties – which could be claimed whether or not any expenditure was actually incurred – has been removed. From April 2016, landlords will only be able to claim for costs they actually bear in replacing fixtures and fittings.


And finally, the Bank of England has proposed new rules to make it harder for landlords to get a mortgage, which is predicted to prevent one in five loans being issued. The Bank claims these new standards “will lead to a decrease in the number of cumulative new approvals for buy-to-let mortgages by about 10% to 20% by the third quarter of 2018”.


According to George Osborne, the chancellor, this attack on Britain’s landlords ensures “people buying a home to let should not be squeezing out families who can’t afford a home to buy”. The proportion of homes owned by households with a mortgage fell from 42% in 2001 to to 31% in 2014, replaced by an army of small landlords: between 2007 and 2016, buy-to-let doubled its share of total mortgage lending from 8.5% to 17%.


So, the big question is whether these tactics will work to halt the decline in UK owner occupation by dampening demand from buy-to-let investors. The answer is almost certainly that it won’t.


First, assuming that the 3% stamp duty surcharge on second homes will be fully reflected in the price of all property, house prices will soon decline by roughly 3%, bringing them back to where they were last summer. Therefore, unless you’ve only been priced out of the market by the last nine months’ price inflation, the stamp duty changes won’t improve matters much.


Second, other than those buying rental properties without a mortgage or inheriting them and becoming landlords, the Bank of England’s own research reveals that two-thirds of buy-to-let mortgage holders only pay the basic 20% rate of tax – only a small minority will be adversely affected by the tax relief changes therefore.


Third, three-quarters of all loans already meet the Bank of England’s new underwriting standards. Its claim that these new standards would reduce new mortgage approvals by 10% to 20% is disingenuous – what this actually means is that, instead of the Bank anticipating a 20% annual rise in buy-to-let lending over the next two years, its action will slow that increase down to about 17% a year.    


The buy-to-let boom has come about because the key underwriting criterion relevant to landlords sets rental income, not employment income, against future interest burdens. Given the continuing high demand for homes, buy-to-let generally satisfies that test … and is almost certainly here to stay.