Buy to Let Property – Still a good idea?
It has been well documented that the English are obsessed by homeownership. Not satisfied with owning their own castle, the last few decades have seen investors intent on owning a string of castles in the quest to achieve both capital growth and an eventual steady predictable income stream to boost pension income.
The concept of owning one or indeed a portfolio of buy to let properties really became popular in the second half of the 1990s; this came about for a number of reasons:
- Lenders relaxed their lending criteria at a time when the UK property market was surging upwards; the loan to value requirements for buy to let mortgages became much less restrictive for example 75% to 80%. This significantly reduced the capital required to make the investment possible.
- Property developers offered guaranteed rental periods to investors for the first one or two years; these deals were coupled with deposit and stamp duty incentives. These rental guarantees compared very favourably with the yield achieved at the time from equities and bonds.
- The value of UK property rose rapidly from the late 1990s. The Halifax Housing Index believes that UK house prices have risen by 101% adjusted for inflation since 1983.
- As an investment concept, property was easy to understand, the majority of investors owned their own homes and felt safe in owning an asset that was tangible. The rise of DIY/makeover television programmes highlighted the apparent relative ease to make a quick buck.
- The Association of Residential Letting Agents promoted the concept of being a landlord and tried to explode the Mr Rigsby persona of Rising Damp fame.
However, the recent crash in house prices in 2008 and subsequent lending drought that hit brought a marked slowdown in private buy-to-let transactions. But appetite seems to be returning from both investors to make their property millions while banks are beginning to offer reasonably priced mortgages again.
But is it still a good idea to follow Sarah Beanie into the murky world of property investment?
As with any type of investment, there are pros and cons to consider:
One of the main disadvantages with direct property investment is liquidity. It is not possible to sell a small portion of a property to realise capital or make use of the individual Capital Gains Tax allowance on a small part of the property. One way to realise capital from a buy to let property is to increase the lending secured against it. This may prove difficult when lenders are unwilling to lend or values have fallen.
Property is relatively expensive to buy and sell. The impact of stamp duty, agent’s fees, legal fees and lending costs all add up and increase the necessary funds required to make an investment. This can be contrasted with the much lower cost associated with the purchase directly held equities or a basket of collective investment e.g. unit trusts. There are also the additional fees charged if you use a managing agent and mortgage payments to meet during void periods.
These days the banks demand a significant chunk of equity from the investor as a deposit, typically 25% of the purchase price.
Buying a buy to let property puts all your faith in a single asset class. It is possible to add some diversification by choosing different types of properties and different locations, fundamentally though it is difficult to try and hedge out the risk of exposure to the UK housing market. Investors could look overseas but putting your property out of easy reach may be too high a price to pay for this level of diversification.
With any asset an investor hopes for a mixture of income and capital and a buy to let property can certainly provide both of these. With a buy to let property investors face tax on any income above the interest-only mortgage payment and tax on any capital gains accrued through the period of ownership. There are some allowances for each of these. Fundamentally however, no political party in or out of power has ever given tax breaks to incentivise private individuals to own more residential property than they need for their own personal use. Conversely, successive governments have tried to alleviate the savings deficit in the retirement market, by providing generous tax breaks on pension contracts; investing in small start-up companies through Venture Capital Trusts and Enterprise Investment Schemes also attract useful tax benefits.
When you buy a property you mix your cash with that lent by the lender. If the value of the property rises your gains are amplified by the combination of this equity and debt. This means that the Return on Capital Employed (ROCE), i.e. the cash you have spent, is much greater than if you had bought a much smaller property for cash or bought an asset like a share or a bond on a one for one basis.
The fundamentals of buying, letting and selling property are straightforward. Owning one or a number of investment properties is not as complicated as analysing asset classes or company accounts; a buy to let investor owns a tangible asset that they understand.
A canny buy to let investor is looking for a predictable income stream that keeps pace with inflation and hopes for potential capital withdrawals through further borrowing should the market rise, and lenders allow. This predictability is certainly achievable if an investor finds a good quality, low maintenance property, situated in a good location with a high demand for tenants. This dream might quickly be shattered though if the location falls foul of some crazy local planning decisions or a change of usage leads to a large modern new build housing estate materialising on your doorstep!
Property investment is a serious business that caries significant costs and risks. Professional legal and financial advice should always be sought before considering this type of investment.
Your home may be repossessed if you do not keep up repayments on your mortgage or other loans secured against it.