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The 1,400% returns figure for Buy-to Let was grossly inflated
In fact it was both gross and inflated. It was also fictitious, and contained errors. It may have led George Osborne to introduce Section 24.
In a recent article purporting to criticise Guardian readers for vilifying a woman who had told them in an earlier article how much profit she had made on selling her only rental property, Patrick Collinson stoked their rage with a fake statistic. He wrote “Financially speaking, buying to let has been probably the best thing anybody could have done with their money since 1997, with gains averaging more than 1,400% since then.” LINK
This implied that the average capital gain was 14 times the purchase price, that prices were 15 times higher now than 20 years ago.
The statistic was overstated by 493%. In other words, it was nearly six times too big.
The national increase was 236%.
Patrick Collinson’s figure appeared in the headline of a Guardian article in 2015 LINK
“On average, £1,000 invested in a buy-to-let asset in the final quarter of 1996 was worth £14,987 by the end of last year, according to analysis by economists at the Wriglesworth Consultancy for lender Landbay, published on Saturday. This was more than four times than the equivalent investment in commercial property, UK government bonds or shares and seven times the return on cash.
Years of rising house prices mean that despite the slump after the financial crisis, property investors who bought 18 years ago are still sitting on large capital gains.”
This implied that prices had increased by a factor of almost 14, in 18 years.
The figure came from a report by the Wriglesworth Consultancy in April 2015 called Buy-to-Let Comes of Age which can be downloaded from the section White Papers at https://landbay.co.uk/reports
This report made it clear that the figure was not the price increase percentage, it was the return on investment (ROI) from mortgaged property. The calculation combined the gross capital gain with the before-tax profit from 18 years of rentals, and was divided by the deposit (thus ignoring the purchasing costs).
Because the deposit was only 25% of the purchase price, the return was much greater than it would have been without a loan. That is why mortgaged properties outperform passive investments – as long as prices are rising. Because of the high cost of property most buyers need to borrow – only a minority of people can afford to buy property without a loan. The magnification of the return results from this. The fact that the deposit was a quarter of the purchase prices is the reason why the return was “more than four times than the equivalent investment in commercial property, UK government bonds or shares”.
And it is thanks to landlords’ability to borrow that the stock of dwellings in the PRS increased by 2.5 million between 1996 and 2013 in England alone.
“From 1996 to 2013, the total number of dwellings in England increased steadily from 20.3 million in 1996 to 23.3 million in 2013. Much of this was due to the notable growth in private rented housing which more than doubled in size from 2.0 million to 4.5 million over this period.”
Thus 2.5 million out of the 3 million increase was thanks to the PRS. That is 83%.
Landlords did this by financing new builds, by rehabilitating run-down properties or by converting large residential or commercial buildings into flats or houses in multiple occupation (HMOs).
In 1996 the UK population was 58.2 million. By 2013 it had increased by 5.9 million to 64.1 million, while the number of dwellings only increased by 3 million.
The younger generation owes BTL a debt of gratitude because if landlords had not increased the supply, both prices and rents would have been even higher than they are now. Instead they vilify landlords because they have been indoctrinated against BTL by a number of ignorant people, some of whom have articles published in the Guardian.
Contrary to the common belief, BTL did not cause much of the rise in prices. . The National Housing and Planning Advice Unit (NHPAU) stated in 2008 that the BTL sector was responsible for increasing average house prices by 7% between 1996 and mid-2007 (when the housing market ground to a halt) but that average house prices rose by 150% in real terms during this period.
It stated “Between 1996 Q3 and 2007 Q2 the overall impact of BTL on house prices was relatively modest and illustrates the point made by others that movements in house prices are largely determined by fundamental economic and demographic factors (Meen etc).” LINK
So BTL was responsible for only one-twentieth of the increase.
The Wriglesworth report was written just after the change in pension rules in order to drum up business for its client Landbay, which allows ordinary investors to lend directly to landlords,, as it explained on page 9. Landbay were offering interest at 3% above BoE base rate. LINK
So a report boasting of 1,400% returns was issued to encourage people to put their money into something that paid 3.5%.
But the 1,498.7%.statistic is, literally, fictitious, despite its ostensible accuracy. It is the result of pretending that someone bought a property at the average price in 1996 and let it at the average rent until 2014, paying 25% in operating costs and interest at BofE Base Rate plus 1.75%, with 3 weeks of voids or arrears each year. The capital gain was taken from a price index that excludes BTL properties.
Apart from that, there were various errors of principle. It ignored income tax on rental profit, pretending that the gross profit could be paid to the lender every year to pay down the mortgage. It ignored the selling costs that would be incurred for the capital gain to be realised and, more importantly, it ignored the tax on the capital gain. And, although purporting to measure the returns over 18 years, it ignored the effect of general inflation in that period.
Rob Thomas, Director of Research at Wriglesworth Consultancy wrote the report. He took what he called the average price for the UK as a whole at the end of 1996, £55,000, and put it into the Nationwide’s calculator. He selected a calculation of the value in the last quarter of 2014, and got the result of £188,421, which he rounded up to £189,000. LINK to Nationwide report
The returns were described as arising from “an average buy-to-let property”, but buy to let and cash purchases are explicitly excluded from this index.
For rents he took the average level from rental data for December 2014 provided by LSL Property Services, and extrapolated this all the way back to 1996. He assumed that the costs of buying and furnishing the property average 3% of the purchase price.
No details of rents or rental profit are shown, so there is no way to check them. But income tax was ignored. On page 10 he states “As is standard in such comparisons, the returns have been calculated gross of tax as different investors face different tax rates. Income is reinvested in the asset.”
To follow this principle he deducted the annual rental profit from the loan, which paid it off in 13 years, thus making the last 5 years interest-free and the profits higher. In the real world, income tax of between 20% and 45% would have been due, making the loan last longer and the interest-free period shorter. This means that profit was overestimated.
But a landlord is more likely to use the after-tax profit to live on, rather than pay it down. So the interest payable would have been higher still, and the profit lower.. .
His table on page 10 shows that the theoretical rental profit (called net income) worked out to be 28.6% of the total return, making it about £59,000 over 18 years, or on average about £3,280 a year before income tax.
The remaining 71.4% of the total returns of 1,489.7% came from capital gain, i.e. 1,063.7%.
But the capital gain is wrong. Instead of deducting the purchase price, he deducted the loan amount. So the capital gain is overstated by the amount of the deposit, in this case £13,750.
There is no deduction for the capital gains tax liability that arises from an increase in prices, or for the selling costs that would be incurred in realising the gain.
However, the most striking omission was the failure to adjust for 18 years of general inflation, which averaged 2.9% a year. £1,000 in 1996 would have inflated to £1,677 by 2014.
I have used his purchase costs, and assumed some selling costs, and calculated the CGT. Then I adjusted the result using the BofE’s inflation calculator, assuming that the loan had not been paid down at all.
|Purchase price from deposit||13,750|
|Purchase price from loan||41,250||41,250|
|Estate agent’s fee||2,268|
|Net, in 2014£, re-stated as||108,316|
|real, in 1996£||64,604|
|Deposit plus costs||15,447|
|Return on deposit plus costs||318%|
|Return on total cost||87%|
The inflation adjusted return from the capital gain was £49,1497, or 87% of the cost, about 4.8% for each year of ownership. It represented inflation-adjusted ROI of 318%. That is less about three-tenths the figure claimed in the report.
Adjusting the (overestimated) £59,000 rental profit for inflation brings it down to £46,000 in real terms. Applying income tax merely at the base rate reduces it to £36,800. This is 65% of the cost, or 238% ROI.
So the overall return in real terms was 152% of the cost, and the total ROI was 556%. The report’s 1,389.7% was two and a half times this figure.
The report had a disclaimer, but it was not that the past is no guide to the future.:
“Disclaimer: This material is for informational purposes only. It is not intended as investment advice and we are not soliciting any action based on it. The material is based on information that we consider reliable, but we do not represent that it is accurate or complete and it should not be relied upon as such.”
Unfortunately, people did rely on it. It was featured in several national newspapers, always with something like this comment in the Daily Mail “But they will alarm campaigners concerned that buy-to-let landlords are pushing up house prices and making it even more difficult for young people to get on the property ladder.” Somebody must have added this propaganda to Wriglesworth’s press release.
Natalie Bennett of the tiny Green Party quoted the figure in the the TV debate before the 2015 general election. The BBC’s fact checker said it was correct, based on the Wriglesworth report!
Under the heading Private landlords, it stated “Natalie Bennett said that private landlords had made 1,400% profit since 1996, far more than investing in other areas.
This figure comes from a report produced by Wriglesworth Consultancy, which was sponsored by buy-to-let lender Landbay.”
A few weeks later Osborne stole her party’s manifesto commitment and disallowed finance costs, and broke David Cameron’s widely televised manifesto pledge that income tax would not go up if he were re-elected PM.
The trumpeting of 1,400% returns from BTL (to induce people to lend money at 3.5%) probably led to Osborne’s decision.
The theoretical rental profit is modest. Most of the return is due to capital gains. The latter are the result of politicians failing to ensure that the supply of dwellings increased to accommodate the population increase, especially in London. But landlords are being punished for the growing imbalance between demand and supply which caused prices to rise.
Patrick Collinson’s article continued “But the losers are the younger generation, who are now unable to get on the property ladder in large parts of the country, particularly in the capital.” No, they were winners because BTL increased the supply of dwellings significantly.
He went on “Tax hikes on buy to let and changes to lending criteria have taken the steam out of the market, but more needs to be done – higher rates of capital gains tax on rental properties, changes to the AST to give proper protections to tenants and stricter lending criteria are just a few of the options.”
CGT on the sale of rental properties is already higher than on any other type of asset. Stricter lending criteria have already been introduced. If by “proper protection” he means reforming what he calls the “no fault” eviction, and going back to the era of lifetime sitting tenants, that would also discourage landlords from increasing the supply of dwellings, which would not be in the interests of the younger generation.
His “remedies” are based on ignorance and prejudice. They are the opposite of what is required. Prices would be even higher if it were not for BTL. The way to help the younger generation is to encourage BTL to increase the supply of dwellings, not discourage it. The solution is to reverse the tax hikes on BTL and the CGT differential.
— Mark Alexander (@iAmALandlord) August 21, 2017
Exaggerating the success of businesses is done to whip up jealousy against ‘capitalists.’ It’s very destructive. @pcollinson
— Rosalind Beck (@RosalindBeck) August 21, 2017
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