Property is not necessarily all is cracked up to be... (Photo: Flickr/Chris Ford)

Property is not necessarily all is cracked up to be… (Photo: Flickr/Chris Ford)

The current Government really doesn’t like properties that are owned by anyone other than the occupier.

The last two Budgets have seen a tax on buy to let landlords, in the form of removing higher rate tax relief on mortgage interest payments in the July Budget and adding an additional 3% stamp duty in December.

The next obvious change is capital gains tax which currently stands at 28% but is for all intents and purposes a tax on inflation as no allowance is given for the period that you own a property for.

Property is the only investment class that I can think of which pays income tax, capital gains tax, VAT (on management fees) and inheritance tax on death. Many investment tax wrappers reduce or remove these taxes, for example, pensions and ISAs.

Part of me thinks that as many individuals buy property for emotional reasons (they like the “bricks and mortar” comfort they receive) the new increase in stamp duty, and even an increase in capital gains tax will simply be paid and reduce yields further.

There are some high profile professional landlords who have been getting rid of their properties and I sincerely wonder whether the market for landlords has had its day but if you are in any doubt the table below shows the current regime and how it is particularly unkind to individuals irrespective of whether they purchase a property with or without a mortgage:

The tables below highlight how the changes on mortgage interest reduce net yields, and also how gearing (use of the mortgage) and tax can also reduce (and increase) returns on properties.

All of the scenarios below assume:

  • Mortgage of £150,000
  • Property price of £200,000
  • Rent of £800 per month

Additional assumptions are given in the relevant section:

Comparison of old versus new mortgage interest relief rules

This table shows the reduction in net yields for higher rate tax payers.

Current position
Rent income £9,600
Mortgage £6,000
Gross “Profit” £3,600
Tax on rent £3,840
Full mortgage deduction £2,400
Tax due £1,440
Net profit £2,160
Effective yield (on equity) 4.32%
New position
Rent income £9,600
Mortgage £6,000
Gross “Profit” £3,600
Tax on rent £3,840
New mortgage deduction £1,200
Tax due £2,640
Net profit £960
Effective yield (on equity) 1.92%

The effect of tax and gearing on property returns

Additional assumptions:

  • Cost of purchase uses Stamp Duty, £1,500 legal fees
  • Cost of sale uses 1.25%+VAT agent fees, £500 legal fees
  • All running costs assumed to be met from income
  • Capital gains paid at 28%
  • Property is held for a ten year period

Property is one of the view asset types that people are willing to borrow to invest in. In considering the purchase of a property an investor needs to think about the yield, which has shown above will reduce for many people. A negative yield means a property is costing money to run.

At the same time capital growth is not guaranteed, and the table shows that if, on average, a property was to grow (or fall) in value capital gains tax, gearing and other costs affect the final return on capital.

It is worth noting that to purchase the £200,000 property in the example above capital of nearly £60,000 is needed, despite using a £50,000 mortgage. If the £60,000 was invested in another way, and using the “3% anticipated capital growth on property” row, an alternative investment would need to generate 5% to give the same final outcome.

Properties are illiquid of course, and on the downside of the negative returns there is the very real risk a lender may make a ‘margin call’ (ask for more money to offset the higher loan-to-value, or even ask for full repayment of the debt).

Total effective return on capital if property values grows by… Effective growth on the capital employed
-3% -15%
-2% -9%
-1% -5%
0% -2%
1% 1%
2% 3%
3% 5%
4% 7%
5% 9%

Conclusions

I’m going to guess that the analysis above is more complex than many would assume it might be. There are also many other factors to consider, not least it is not as simple to segregate income from capital growth as I have.

However I hope I’ve given a flavour for some of the risks of property and would be happy to bear the cost of a further discussion.

Opinions & Insights

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