Category Archives: Property

Under 40? Invest £4k per year in a LISA and wind up with up to £1m at 60.

From April 6th 2017, a tax efficient savings account will be available for anyone between the ages of 18 to 40. I fall into this age bracket so I decided to put together a basic spreadsheet to figure out whether LISA’s are worth looking into – you can  look at my spreadsheet  below if you like (there is a download link below the spreadsheet).

You can find a good summary of LISA’s here at moneysavingexpert.com so I will not explain them in detail. The wrinkle I have added is a very simple strategy of investing in a low cost investment vehicle. I did the analysis using a stocks and shares LISA not a cash LISA, which in real terms given current interest rates would wind up costing you money (since inflation > interest earned on cash).

This is the investment vehicle I have used in my calculations. I have assumed a long term return of 6.5% per annum which includes dividend reinvestment. It is designed to replicate the performance of the FTSE 100 index and charges only 0.09% in fees (over time this fee can make a substantial difference to your overall return).  For example, an 18 year old paying in £4,000 per year until age 60 would be £359,314 worse off paying 1.5% in fees rather than 0.09% – amazing but true (see for yourself using the calculator and read this book – you will understand why money managers get a much better result than their clients).

Compared to pensions, LISA’s have their pro’s and con’s and I will leave it to you to figure out which you should invest your money in (if you are not sure get some advice from a properly qualified professional – but be mindful of fees!) Also bear in mind, the 25% government bonus could be reduced at any time.

I just wanted to illustrate a simple, tax efficient and low effort way for anyone starting out to invest for the long term without taking excessive risk.

Parmdeep Vadesha

Download link: https://docs.google.com/spreadsheets/d/1nI36S4y1jSsWa5w0-K_f3oiwH-dVI1dXf90KAEi5FYU/edit#gid=967393783

 

 

 

 

 

Time To Exit The Property Market?

During the 2016 Christmas break I put some time aside to think about whether my strategy still makes sense given the new risks and opportunities that have recently appeared.

My strategy is simple: to grow my net worth at an average rate over a long period of time that exceeds the return I could get from doing nothing. If I cannot do this, then I should not bother running a business – simply investing my funds into a low cost stock market tracker fund, say an ETF, would deliver better results for less risk and no work. Smart investors estimate a long term return from the stock market of 6%-7%.  That would turn £100,000 into £1.8-£2.9m over 50 years. A return of 12% would instead result in £28.9m. No wonder Einstein once said “Compound interest is the eighth wonder of the world. He who understands it, earns it … he who doesn’t … pays it.”

image

Since most people prefer high returns to low, especially in a low interest rate environment, so the competition for deals must increase. This has led to prices for many investments spiralling out of any sensible bounds that a value investor would consider paying given the likely long term return and risks involved. Property prices for example have increased much further and faster than rents suggesting a high level of speculation (people buying because they think market values will continue to increase).

screenshot-2016-12-31-at-17-08-56
Source: FT

One vivid example… An old Severn Trent water pumping station near me recently went to auction. The property had the potential for conversion and extension to form a block of flats. Severn Trent sold the property on the basis that the buyer would give ST a range of pretty restrictive rights, for example the permission to dig anywhere around the perimeter at any time they wished. They also wanted a share of any planning permission uplift for a long period of time, over 30 years I believe.

I figured there could be an investment here at the right price, having taken the challenges into account. I valued the property at only £45k to account for the risks involved. The eventual buyer went to the auction expecting to buy something else, missed out, then blindly bidded for this and wound up paying £92k. The story doesn’t finish there… Having realised his mistake, he then put the property straight back into a different auction and sold it to someone else for £128,500! Another friend recently put a property on the market expecting £250k, maybe £300k at a push… He sold it for £450k – way over it’s investment value. I can think of many other examples – we went for a property and it sold for way more than we thought it was worth.

This disconnect between risk and return, must indicate that inexperienced investors are actively buying, since they are less likely to understand what can go wrong and account for that by insisting on a margin of safety. Low interest rates are pushing them into risky assets that will perform poorly should market conditions deteriorate. This phenomenon is not just limited to property – it is pervasive.

Recent changes affecting investors – 3% stamp duty surcharge, loss of mortgage interest relief, wear and tear allowance changes etc.

There are around 2m landlords in the UK, who own around 5m properties. About 65% of all these properties are owned entirely mortgage free. The remaining 1.75m are mortgaged at only around 46% on average. So, overall, the changes to mortgage interest relief are going to disproportionately affect the small subset of property investors who are entering the market at high LTV’s, purchased relatively recently with a high LTV mortgage, or refinanced to the same position. Newer entrants are much more likely to be on interest only loans, which are a new invention, and since they are not paying down the debt over time they are going to be doubly hit.

The 3% stamp duty surcharge will only affect those entering the market or adding to their existing portfolios. True long term investors will simply factor the 3% into their calculations and try to negotiate a discount on the purchase price, or swallow it since the long term return, which includes all net rental income received and capital gains, is hardly affected. New entrants to the market are more likely to be put off.

These changes discourage entry to the market which helps not hinders long term investors.

These legislative changes can only be good news for experienced investors who leverage their investments sensibly and manage their properties intensively. Since just 1% of the UK’s housing stock is owned by institutions, compared to 13% in the US, 17% in Germany and 37% in the Netherlands, it seems likely these are the types of investors these Government interventions have been designed to encourage.

Should property investors get out of the market? 

An uncomfortable fact: the vast majority of renters would prefer to own a house than rent one. However, out of control property prices have resulted in their ability to buy becoming greatly diminished, impossible in many cases. This does not make landlords as a whole particularly popular (only 2% of the population owns more than one property). This is why we are vulnerable to changes in government policy – nobody really cares about us (did your tenants send you Christmas cards?)

By reading Internet comments related to property articles, it is clear that (rightly or wrongly) some people resent how investors are making it hard for them to get on the ladder. I think the issue could be deserved vs undeserved wealth. I do not think people generally have a problem with deserved wealth (nobody seems to mind when an Olympic cyclist makes a packet for example), but wealth generated by people who do not seem to have worked very hard for it angers people.

Let’s face it, many property investors have been lucky. I do not recall speaking to anybody or reading anywhere, that properties purchased in London in 2011 in London were going to skyrocket in value over the next 5 years but that is pretty much what happened. Those who had the ability to buy, and did so, did very well.

Lucky we have been, but will it continue? The current property price trends do not look sustainable – prices can diverge away from average income for only so long and the UK is way out in front for expensive property on this measure:

screenshot-2016-12-31-at-18-33-27
Source: Economist.com

An adjustment in prices, assuming people who currently rent and have deposits to buy could buy, would be good for everybody and what we should be hoping for. And lets not forget, there is the side benefit of long term investors being able to buy a few more investment properties.

In the meantime, I will continue to buy and sell.

 

Parmdeep Vadesha

P.S. Housebuilders are finding this a good time to buy and sell judging by their profit margins – they are back to where they were when the market last crashed.. Food for thought:

image-1Source: Annual reports, Persimmon & Barratt

P.P.S. If you have development deals that you want to JV on, or you want to invest in some of our projects (please note there is a waiting list for investors as we generally have more money than deals) then visit this site to find out more http://www.hawkblue.com/

BTL Tax Changes Part I: How Does It Affect You?

BTL Tax Changes Are Here!

Osborne Wallpaper

Jimmy – S via Compfight

Tax. A small word, large implications. We all want to pay less of it, or avoid it. But, as my accountant likes to point out: Paying tax is good news, it means you are making a profit and doing something right.

However, the recent budget changes announced by George Osbourne changed the parameters of what constitutes taxable profit.

Up until last year, your taxable profit on residential buy-to-let was calculated as:

Taxable Profit = Gross Rent Received – Allowable Expenses – Mortgage Interest – Wear & Tear Allowance

The wear and tear allowance applied to properties that are let fully furnished.  For such properties, you could offset 10% of your rents received for that property to allow for depreciation (wear and tear) against your supplied furnishings. In properties with high rents, such as in London and the South East, this was a considerable allowance. This allowance has already been removed for 2016-17 tax year onwards.

Allowable expenses included items such as letting agency fees. Crucially, mortgage interest, usually an investors largest expense, was subtracted in full to arrive at the Taxable Profit.

Once you subtracted these from your gross rents, you paid tax on what was left, at your marginal rate (i.e. on top of any other earnings, such as a salary from your job).

Let’s take a simple example: You have a job, paying £55,000 per year. You have two BTL’s, grossing £15,000 in rent. Allowable expenses total £2,000 and you let both furnished, so you enjoy £1,500 (10% of gross rent) as a wear and tear allowance. Finally, your mortgage interest is £9,000 per year for both properties.

Currently, your taxable profit is worked out as:

Taxable Profit = £15,000 – £2,000 – £9,000 – £1,500 = £2,500

So you would pay tax at your marginal rate on £2,500. Given you are a higher rate payer (salary = £55,000), then you would pay £2,500 x 40% = £1,000 in tax on your buy to let business.

However, the budget of 2015 changed this significantly. It was announced that it was considered unfair that higher rate taxpayers were given mortgage interest rate relief at 40%, to the detriment of owner occupiers who didn’t get the same benefit. Therefore, starting from the 2017-18 tax year, the amount of interest rate relief would be reduced in stages, capped to a maximum of 20% by 2020, as follows:

  • 2017-18: Tax relief limited to 75% of mortgage interest costs
  • 2018-19: Tax relief limited to 50% of mortgage interest costs
  • 2019-20: Tax relief limited to 25% of mortgage interest costs
  • 2020-21 onwards: Tax relief limited to 20% (basic tax rate) of mortgage interest costs

Cue much gnashing of teeth by landlords, most of whom probably voted Conservative in the last General Election. There is plenty of discourse on various forums about these changes and the motivation, so I won’t go into them here. Suffice to say I think this is more of a governance issue than a revenue raising attempt, as regulating and taxing large players in the form of corporate entities is much easier than thousands of individual landlords.

As property investors, the key questions to understand the answers to are:

  1. How it affects your portfolio
  2. How does it affect your decision making going forward

In this blog post I will address the first question, with a follow-up blog post looking at the second question and help you understand if you should be adding another purchase to your portfolio and under what terms.

Redefining Taxable Profit

What makes this tax change particularly painful, is the way it is being calculated. Now, taxable profit will be calculated as:

Taxable Profit = Gross Rent Received – Allowable Expenses

There is a double whammy here. Mortgage interest is not discounted up front. In addition, another change announced in the budget was the removal of the wear and tear allowance.

Once the tax has been calculated at the marginal rate, only then can you offset a proportion of the mortgage interest, which by 2020 will be capped at 20%.

To take our example from above (salary of £55,000, two BTL properties grossing £15,000 in rent and £2,000 allowable expenses), then then taxable profit is:

Taxable Profit = £15,000 – £2,000 = £13,000

Quite a big difference from the taxable profit of £2,500 under the old rules!

You will now pay tax at your marginal rate on £13,000. With a salary of £55,000, this would be at 40%, i.e. £13,000 x 40% = £5,200.

By 2020, you will only be able to subtract 20% of your mortgage interest costs against this tax bill. With mortgage interest of £9,000, you would be able to claim £9,000 x 20% = £1,800 to offset your tax bill of £5,200. There is no longer any wear and tear allowance. This would result in a tax bill of £5,200 – £1,800 = £3,400. This is considerably more than the tax bill of £1,000 payable under the current rules.

Paying More In Tax Than You Actually Made In Net Profit!

One consequence of this is that, for highly geared and/or low profit landlords, it is entirely possible to have a tax bill greater than the actual net profit you are banking. Clearly, this can make such portfolios unsustainable unless you have other sources of income from which you can pay the increased tax.

If you are a lower rate taxpayer, whose combined property income and other income is below the higher rate tax threshold (which will be £45,000 for 2016-17 tax year), then there is no change to your tax position.

However, if you are a lower rate taxpayer in your day job, but by adding your property income you are taken into the higher rate band, then you will now pay 40% tax on some of your property income as you can no longer deduct mortgage interest before calculating your taxable profit.

BTL Tax Calculator

Notebook and calculator

Pixelmattic WordPress Agency via Compfight

In order to help you assess the impact to your own portfolio, I have put together a BTL Tax Calculator below.

To use it, all you need to know are the following input parameters:

  • Total Gross Rental Income across your portfolio, minus allowable expenses.
  • Total Mortgage Interest across your portfolio.
  • Total Other Income, e.g. your salary from your day job. If you are full-time landord, leave this as zero.

The BTL Tax Calculator will then work out your current tax position and the impact by the time the changes are fully phased in by 2020. It assumes that the tax bands will change as previously announced by the treasury, with the target for the 40% tax barrier expected to rise to £50,000.

As always, you need to think rationally and consider your own tax position before making any large scale decisions – it might not have as bad an impact as the wailing on the property forums would have you believe. If the tax bands rise as forecast, then it is perfectly possible to be paying LESS tax than currently, despite the changes to interest relief.

Disclaimer: Tax is a complicated business ... please seek professional advice before acting on any information given in the BTL Tax Calculator above!

What Can I Do?

If you find yourself facing a tax bill greater than your actual net profit by 2020, then you have some time to rectify the position. The options are:

  • Sell a property and use the proceeds to reduce your LTV on other properties in your portfolio. You can model this in the BTL Tax Calculator by reducing the Gross Rental Income and Mortgage Interest amounts for the property (or properties) you are considering selling.
  • Use other income or savings to reduce your LTV on properties in your portfolio. Again, you can model this in the BTL Tax Calculator by reducing the Total Mortgage Interest amount by the amount of interest you will save by paying down your mortgage(s). Note that most BTL lenders will allow you to overpay by at least 10% per year with no penalty, but check your terms and conditions to be sure. The amount of mortgage interest saved by overpaying can be worked out using the following formula:

Tax Interest Saved = Overpayment Amount x Mortgage Interest Rate

  • Increase the rental income. Rents, particularly in London and the South East, continue to rise. If you have long standing tenants who are still on the same rent when they took up residence, then it is possible they are now paying a rent less than the going market rent and there may be scope for an increase. However, you need to consider an increase against the backdrop of affordability for the tenants and the probability of them leaving your property as a result.  You can model this using the BTL Tax Calculator by increasing the Total Gross Rental Income figure by the annual amount any rent increases would result in.
  • Change the rental model. Do you have any family homes that might make good Houses in Multiple Occupation (HMO’s)? Such properties might yield a larger net cash flow than a single let, although this has to be balanced by the changes required to meet HMO regulations and possible licensing requirements, your local council’s regulations on amenity space, the extra management overhead required, the local demand for room lets, any mortgage restrictions (you may need an appropriate HMO mortgage) and the fact that is usual for the landlord to pay the costs of utilities and council tax. You can model this using the BTL Tax Calculator by adding the additional net rent to the Total Gross Rental Income figure.
  • Incorporation of your portfolio. Properties held within a Limited Company structure are still able to fully offset mortgage interest costs and pay corporation tax on the net profit. However, moving properties from your personal name into a limited company entity is classed as a sale and purchase. This means you may be subject to Capital Gains Tax on the sale of the property and the limited company will have to pay stamp duty on the purchase. In addition, limited company mortgages tend to have interest rates higher than BTL mortgages held in a personal name.. There is also the ‘known unknown’, of whether the current or future Chancellor of the Exchequer will turn his sights on such arrangements. I would suggest seeking specialist tax advice if considering going down this route.

Are These Changes a Good Thing?

On first glance, that seems like a stupid question.

With the additional tax burden, the removal of the wear and tear allowance and the recent introduction (as of 1st April 2016) of an additional 3% stamp duty surcharge on any second property purchase above £40,000 (so this would cover holiday homes for personal use, holiday lets and BTL purchases), it is clear that any property investor is facing strong headwinds moving forward.

But is it all doom and gloom? Remember, these are taxation changes. What does this mean for a property investor?

Consider the impact of these changes on the supply side of property rentals:

  • Likely reduced investment in BTL as such changes act as a deterrent and require more liquid cash to purchase (lower LTV to cover tax changes, increased capital required to afford the 3% stamp duty surcharge).
  • Some landlords will exit the market. Accidental landlords, or those highly leveraged with smaller cash flow will likely have to sell up if they face a tax bill greater than their net profit.

The net result: Less competition for new purchases and less competition for existing landlords as rental stock is reduced. Generally in any business, a reduction in competition is considered a good thing!

Now consider that the demand side for property rentals hasn’t changed. These are taxation changes imposed on landlords. There is the same tenant demand as before these changes, only going forward the supply of rental properties is likely to be reduced and the current rental stock also reduced. This increases pressure on rents and so we are likely to see increases in rents being achieved by landlords and more tenant choice for landlords.

For those landlords able to position themselves to absorb the changes, the future looks positive.

Let me know if you find the BTL Tax Calculator useful. If you have any suggestions for enhancements, let me know in the comments below.

Don’t let your friends and fellow landlords get caught out by these tax changes – share this calculator with them using the sharing icons below or directing them to this blogpost.