11:11 AM, 14th August 2017, About 6 years ago 3
Last week a reader pointed out that the gross yield figures that are bandied about are misleading and we should concentrate on the return on investment (ROI).
Click here to see “We Should Be Using Net Rental Yields”
The gross yield is the annual gross rent as a percentage of the value of the property. The ROI is the after-tax profit as a percentage of the amount invested, basically the deposit where a mortgage is involved.
He did a calculation based on the following average figures: property price £190,000, rent £850 per month, loan 60%, interest rate of 4.5%,running costs which included full management or an employed team for the larger landlord like himself which costs 30% of the rent. He arrived at an ROI of 2.01%. The gross yield is 5.4%
The consensus was that ROI is much more useful. And somebody pointed out that we now have to take S 24 into account as it dramatically reduces after-tax profit where finance costs are incurred.
He asked readers to check his calculation. Using the above figures per unit I tried to calculate how many units he had in order to arrive at an ROI of 2.01%. Assuming that there were no joint owners, and he had no other income, the answer is nearer 40 than 20.
This calculation revealed a paradox. Normally you would expect a bigger portfolio to produce a bigger after-tax income in absolute terms, and this is what happened until last year. As the table shows, after tax income does not exactly double as the number of units doubles, but it grows from £34k to 60k to £103k
However, under S 24, after-tax income will go down in absolute terms as the size of the portfolio doubles, from £10k to £7k to almost nothing – 50p per property per year.
At 81 units the tax will exceed 100% of the real profit.
And at each size, the fictitious profit will rule out entitlement to any benefits.
The owner’s work will just be for the benefit of his tenants, his employees, his lenders and his government.
I then calculated what effect S 24 would have on ROI as from 2020/21 when it is fully phased in. At 20 units it will be reduced by seven-tenths. At 40 units it will be reduced by nine-tenths. At 80 units it will be extinguished.
The effect of Section 24 of the Finance (No.2) Act 2015 on different sizes of portfolio
The real profit figures are on the line “Amount liable to tax” in the columns headed 2016/17
The extra tax is about 45% on the interest, minus the 20% “relief”.
To avoid bankruptcy he needs to increase the rent. He should have started to do so before April when S24 began to be phased in. To maintain the same after-tax income as he had last year he will need to increase the rent by the above percentages before April 2020, from £850 to about £1,050.
It is not sufficient to increase rents by the amount of extra tax because the increase itself will be taxed at 45%.
I have assumed that his 30% management costs do not include any agents fees that would go up in line with rents. If there are, he will have to increase rents even more.Show Book a Tax Planning Consultation
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13:08 PM, 14th August 2017, About 6 years ago
Despite all the publicity, I have no doubt that there are still those out there that are not aware of the impact S24 will have on them, they will not have done the sums and will be in for a big shock come the Yr 17/18 tax return! Only then will they start jumping up and want to understand S24 and it's implications over the next 3 tax years. I can see it now "I was not aware of S24 and HMRC......means I have a negative profit.... why wasn't I told about this.... what can I do?" As the Appalled Landlord has pointed out, the only real figure (since s24) to measure a properties real potential is the "after tax income" figure. This will be very specific to each individual landlord's circumstances and has to be included as a calculation of the whole portfolio and with any other taxable income received. Also consider a significant increase in agent management fees if tenants are no longer chargeable, although this cost could be off set against tax.
Dr Rosalind Beck
8:34 AM, 15th August 2017, About 6 years ago
An excellent explanation which we can now use as a resource when trying to explain how this works to politicians and journalists. Clearly this shows the massive impact on portfolio landlords who have used buy-to-let mortgages (as nearly all will have done; otherwise how could you build a portfolio?) - and on vast numbers of tenants who are seeing rents rise. The commentators who have said landlords cannot increase rents as they are already at maximum frankly don't know what they're on about and don't understand that many/most landlords have never chased the last penny on rents.
8:52 AM, 15th August 2017, About 6 years ago
Reply to the comment left by Dr Rosalind Beck at <a href="<a href="15/08/2017"" rel="nofollow">https://www.property118.com/the-paradox-of-section24/#comment-93611">15/08/2017" rel="nofollow"><a href="https://www.property118.com/the-paradox-of-section24/#comment-93611">15/08/2017https://www.property118.com/the-paradox-of-section24/#comment-93611">15/08/2017</a> - 08:34"The commentators who have said landlords cannot increase rents as they are already at maximum frankly don't know what they're on about and don't understand that many/most landlords have never chased the last penny on rents."
Also if Tenants can't afford the increased rent they have the option to move to a lower cost property either a smaller property inthe same area or a similar size property in a cheaper area. Albeit with the upheaval and costs of moving home. It is those at the bottom of the housing ladder for whom these options do not exist, and therefore are likely to be made homeless.