2020 Vision for Landlords

by Mark Alexander

23:30 PM, 12th July 2015
About 3 years ago

2020 Vision for Landlords

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2020 Vision for Landlords

Will Buy-to-Let still make sense in 2020 when the new tax rules come into full effect? 2020 Vision for Landlords

I have done some number crunching based on 5% gross yield and 5% per annum capital growth.

Here’s a summary:-

Property value say £150,000

Rent of say £7,500 per annum (5% gross yield).

Cost of management, maintenance, insurance etc. = 25% of rent, i.e. £1,875.

Gross taxable profit = £5,625.

Average yearly increase in value £7,500 (i.e. 5% of capital value).

Total return £13,125.

Now let’s add in a financing strategy, say 5% interest on a 75% LTV loan.

Mortgage amount: £112,500

Interest at 5% = £5,625

Tax relief at 20% of interest = £1,125

Deposit required £37,500

The outcome:

Gross rental income = £7,500

Deduct £1,875 for management, maintenance insurance etc.

Deduct £5,625 for interest costs

Rental cashflow before tax = £0

Taxable profit = £5,625 which equates to tax payable as follows

  • If you are still a 20% tax payer after factoring in your £5,625 of taxable profit then you will pay an extra £1,125 of tax, but you will have a tax credit of £1,125 to offset against that due to your tax relief on buy-to-let interest. In other words, your rental cashflow before tax will remain £0 after tax.
  • If you are a 40% tax payer after factoring in your £5,625  of taxable profit (in other words your total taxable income is more than £43,000) then you will pay an extra £2,250 of tax but you will have a tax credit of £1,125 to offset against that due to your tax relief on buy-to-let interest. In other words, your £0 of rental cashflow before tax will become -£1,125 negative after tax
  • If you are a 45% tax payer after factoring in your £5,625 of taxable profit (in other words your total taxable income is more than £150,000) then you will pay an extra £2,531 of tax but you will have a tax credit of £1,125 to offset against that due to your tax relief on buy-to-let interest. In other words, your £0 of rental cashflow before tax will become -£1,406 negative after tax

So in cashflow terms this doesn’t look too clever for a higher rate tax payer does it?

Or does it?

Remember to factor in the capital growth, in our example we assumed £7,500.

OK, that’s not cashflow but it is only taxed at 18% if you are a basic rate tax payer at the point of sale or a maximum of 28% if you are a higher rate tax payer.

So let’s assume that you sell after just one year. I will ignore costs of sale in this example.

  • If you are a 20% tax payer you will have a cashflow of £0 after tax plus a capital gain of £7,500 taxed at 18% which equates to a total profit after tax of £6,150. As a percentage of your initial investment (i.e. your deposit of £37,500) this equates to a return of 16.4%
  • If you are a 40% tax payer you will have made negative cashflow after tax of £1,125 plus a capital gain of £7,500 taxed at 28% which equates to a total profit of £4,275. As a percentage of your initial investment (i.e. your deposit of £37,500) this equates to a return of 11.4%
  • If you are a 45% tax payer you will have made negative cashflow after tax of £1,406 after tax plus a capital gain of £7,500 taxed at 28% which equates to a total profit of £3,994. As a percentage of your initial investment (i.e. your deposit of £37,500) this equates to a return of 10.6%

Now whichever scenario fits you, that’s still a far better return that you will get from a deposit account.

So it it worth it or not? Only you can decide!

There are some other points to factor in though.

  1. Your mortgage balance will not increase with traditional interest only finance
  2. Your rent is likely to increase in line with demand, thus increasing your rental profits and your overall returns over the years
  3. 5% capital growth is not guaranteed, it could be more, it could be less.
  4. You may get more or less than a 5% gross rental yield. The general rule of thumb on this is that higher yielding properties have higher costs and lower capital growth. There are always exceptions to the rule though.
  5. We don’t know whether the government will tinker further. I haven’t factored in Selective Licensing costs either, and that could be applied in your area, even though it might not apply now.

Please discuss.



Comments

Phil Landlord

23:59 PM, 12th July 2015
About 3 years ago

This relies on capital growth which in the past has been a 'bonus' rather than a necessity. It also relies on an ability to fund the BTL cash flow from another source.

It weakens the argument for the person considering a dabble. But those slightly bigger players will wrap new purchases in limited companies and may sell the odd one held already ( and currentky no held in a ltd company) to manage debt ratios.

Mark Alexander

0:13 AM, 13th July 2015
About 3 years ago

Reply to the comment left by "Phil Landlord" at "12/07/2015 - 23:59":

Yes I agree with most of that.

I think far more purchases will be in a company structure, but there are several disadvantages, especially when it comes to getting the money out of the company to spend. Other disadvantages are less availability of finance and higher costs of finance, no CGT Albanian exemptions and higher accountancy costs to name but a few.

Government intention seems to have been to slow down the growth of BTL and I am certain this will happen.

I think the BTL investors of the future will be people who prefer to invest into bricks and mortar than into a pension fund, i.e. they will use what they would have paid into a pension fund to subsidise negative cashflow. There are people already doing that but not many in the grand scheme of things.

My concern is for those of us who have committed to a business model based on the old rules. It is incredibly difficult for those with high gearing to readjust their business models because moving to a corporate structure would incur CGT (no rollover relief) and SDLT. Selling up to reduce gearing would also incur CGT which may well exceed net sale proceeds where an aggressive refinancing strategy based on releasing equity in line with capital growth to accelerate the growth of a property portfolio has been utilised.

Where many existing business model involved gearing up for capital growth and to break even in terms of cashflow/profit the new tax regime could prove to be fatal unless some tax concessions come into play; example scenario which may be considered include:-

1) the new tax rules only apply to new debt or

2) CGT rollover relief is introduced for residential investment property or

3) a CGT amnesty is declared for BTL landlords for a given period. Worst case scenario is that without any concessions we could be looking at another credit crunch. I doubt very much the government will allow that to happen when they have had an opportunity to further consider the ramifications of their budget announcements.
.

0:58 AM, 13th July 2015
About 3 years ago

I'm loving the optimism here Mark !

"the new tax rules only apply to new debt "

Phil Landlord

7:00 AM, 13th July 2015
About 3 years ago

My intent was to leave work at 50 (mid 2018) and live on a modest pension. My small portfolio should nicely top that up and rent split between me and my non-earning Mrs Landlord. At that stage I would have definitely been a BRT. These changes make that plan a definite course of action.

However, before then I will now sell a couple to reduce rent and debt to avoid getting anyway near Higher Rate and just make things simpler. I was probably going to do that anyway.

I have always sold to lock in profits. I buy houses in need of improvement or repair then rent them for several years and sell them renovated. This meant my rentals overall ended up not being very income profitable (voids when selling, repairs etc) but selling has allowed me to generate profits overall on an expanding portfolio.

My personal biggest concern is my model allowed me to carry forward significant income losses (currently @ £70k between us both) which I was going to then claw back in retirement when the properties where earning a more steady income. I fear that those will be quickly lost due to the methodology of working out taxable profit.

My other intent was at 50 to hold £400k debt but £550k cash. To allow me to develop as a side venture. Not now. Depending on total numbers I am more likely to repay debts and enjoy holidays and gardening instead.

Phil Landlord

7:50 AM, 13th July 2015
About 3 years ago

Reply to the comment left by "Phil Landlord" at "13/07/2015 - 07:00":

Sorry, for context should have mentioned £70k income loss sounds a lot but the sale profits more than compensate and this is over the past 15 years and last 2 years am trading in a positive position.

JohnCaversham

12:37 PM, 13th July 2015
About 3 years ago

Mark, you forgot to factor in the tenant that didn't pay for 5 months, the cost of perusing him through a Sec21/8 and the resulting refurb cost, the cost of voids, boiler breakdown new carpets and roof repair....

Osbourne's well and truly pulled the carpet out from under...
Nothing quite like being taxed on turnover not profit.......! Is that even legal?
Not sure where i go from here, certainly a downsize in portfolio is about to happen...

Neil Patterson

13:57 PM, 13th July 2015
About 3 years ago

Calculation amendments have now been made.

Dr Rosalind Beck

19:05 PM, 13th July 2015
About 3 years ago

HI Mark.
Interesting bit of number crunching. I used to enjoy doing projections of my portfolio - how much I'd have if its value grew by 5%, 10% etc. But, in fact, I'd say my Cardiff houses have stayed more or less static in price since 2007, so I don't share your optimism about the increase in value...
Hi John.
I also wonder about the legality and logic of being able to tax on a cost of running a business. I think we have to seriously try to challenge this. If not, they could impose tax on all costs of running the business. They might say we can't claim for the costs of putting in a new bathroom, carpets, furniture, anything in fact? As though it was our personal expenditure and not done as part of an important business that serves the community. I think there might be an issue over semantics and a lack of understanding about the work involved in buy-to-let, which makes it a business and not a simple, hands-off investment.
There are lots of contradictions in the tax laws related to this lack of awareness of what we do. For example, if a letting agent finds tenants we can put their charges in as a cost; if a landlord conducts 20 viewings in order to find one tenant, this counts as 'non-work.' Unfortunately, I'm used to that kind of devaluation of work, having also been a stay-at-home-mom as the Americans call it. When a childminder, taxi-driver, cleaner etc does the work it counts as work, when the mother does it it's invisible.... Both scenarios are based on ignorance by the general population and by the Government.

Mark Alexander

19:43 PM, 13th July 2015
About 3 years ago

A whacky new concept from yours truly 😀

Just suppose I set up a new limited company and I walk into my bank and ask for a big loan, equal to my BTL mortgage.

The first four questions the bank manager will ask me are likely to be:-

1) What is the security?

2) How will you service the loan?

3) Why do you want the money?

4) What is your track record?

I respond:-

1) I am prepared to give him a personal guarantee secured by a charge over my BTL properties which are worth £.........

2) I will create a 25 year lease of my properties to the new company at a rent sufficient to match his interest cover requirements.

3) I want the money to repay my existing BTL mortgages as the tax regime is no longer effective for me. I can't transfer the properties to the company without incurring CGT, which is sadly not available for rollover relief

4) My pedigree as a landlords is ..........

This takes me right back to my problem solving days as a rookie commercial finance broker.

All I need to do now is to persuade a BTL mortgage lender to offer me decent terms. I suspect they are as worried about the Budget announcements as most portfolio landlords are so I suspect they might be a lot easier to convince than some people might imagine.

Have I cracked the problem for established portfolio landlords like me, who will be worst affected by this budget?

Only time will tell 😀

I am very grateful to the Chancellor for giving me two years to fix this problem!
.

JohnCaversham

21:21 PM, 13th July 2015
About 3 years ago

So for those like myself who self manage and don't use a letting agent how about setting up a Ltd Co as a letting agent and charging ourself say around £4k a year per property for tenant find/manage/biannual checks etc etc all those things that Ros points out that we do for free? OK corp tax will be due but you could put a serious dent in your taxable profit to duck back below the £43K limit?? Multiple companies could be set up to keep below vat limits? Maybe should have be doing this anyway pre-budget?
Think-what would the likes of Branson/Sugar do?-(as if they even pay tax here!)

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