Does Housing Still Pay it's Way?
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The change in the government’s attitude towards private landlords has made investment costlier than it was. The 3% stamp duty surcharge, upcoming tapering of mortgage interest relief, reduction in the wear and tear allowance combined with the clampdown on the availability of mortgage finance at higher loan-to-value rates, all add to the costs for landlords.
We know that property has outperformed many other assets over the long-term, and with interest rates at historic lows, yields on alternative investments are thin. On top of that, property is often seen as being more tangible, making it an attractive investment for many. But, with all these extra obstacles the government has thrown its way, is housing still an attractive investment?
Typically, gross yields, expressed simply as annual rental income as a proportion of the property value, are at the forefront of talk about the attraction of a rental investment. But, as this does not consider the many costs associated with buying and owning a rental home, it does not reflect the true return of the investment. Net yields, which consider the expenses associated with owning a rental home, provide a more accurate picture – especially as the new government measures aim to soften interest in the rental sector by increasing the costs associated with buying and owning a rental property.
Gross yields do not consider the stamp duty element of the purchase so it is perhaps not reflecting the true returns on the initial capital outlay.
Taking stamp duty into account can have a material impact on relative yields – particularly following the introduction of new rates for second home purchases. The initial change from the old slab structure in 2014 benefited most landlords as it made the tax bill on homes less than £1 million, the price range which most individual landlords would be transacting in, cheaper. But the extra 3% landlords now need to pay has stacked the deck against them. Prior to the 2014 stamp duty reform, the average UK landlord paid £161,550 for a home and faced a stamp duty bill of £1,616. When the slab structure was abolished, this fell to just £731. However, the new stamp duty surcharge now means that the average landlord would now face a bill of £5,578 – a 663% increase.
If stamp duty costs are included in yield calculations, it has a knock-on effect on the yields which landlords can achieve in the first year of owning their rental property. An average landlord, prior to the stamp duty surcharge, could achieve a yield of 5.5% when including the cost of stamp duty into the first year’s yield calculation. But the new stamp duty surcharge would push this yield down marginally to 5.3%. However, stamp duty is an upfront cost which acts as a transaction tax, so most landlords aim to recover this cost through capital growth over a longer time period, rather than through their income in the first year. Yields are most accurately calculated by adding stamp duty to the purchase price which can be spread across the whole period of ownership.
Mortgage tax relief and wear and tear
The changes being made to the mortgage tax relief and the removal of the wear and tear allowance will squeeze incomes for both new and existing mortgaged landlords.
Previously landlords only paid tax on their rental profits after deducting mortgage interest costs and a wear and tear allowance, set at 10% of their annual rental income. But the former Chancellor announced that in 2017 the government will begin the gradual tapering, over a four year period, of the relief on mortgage interest so that by 2020 the tax relief will be fixed at the basic 20% income tax rate. Additionally, landlords will only be able to deduct the actual cost incurred for replacing furnishings and appliances as their wear and tear allowance – redecorating costs and other elements of improvements are no longer included.
This will affect the annual income landlords can receive from their rental homes, particularly those whose income crosses the higher tax threshold. After 2020, an average mortgaged landlord in Great Britain, with a 70% LTV interest-only mortgage, at the lower tax threshold, will see the yearly net income they receive from their property fall from £5,400 to £5,000. Those on the higher tax threshold, will see their income fall from £4,000 to £3,400. In most regions, landlords on a lower tax threshold will see no changes to their income.
Importantly, even with the full impact of the tax changes, an average landlord is still able to turn a profit from their rental home. However, landlords will need to look at their sums prudently, especially larger ones. The tax changes will have a marked impact on larger landlords who own a portfolio of several rental homes, particularly those who are highly geared and own properties in the more expensive regions.
For example, a higher tax paying London landlord with a portfolio of five properties and 70% LTV mortgages on all properties, will see their tax bill increase by nearly £12,000 following the full implementation of the new tax changes.
But rental yields are rarely the focus
While mortgaged landlords, both new and existing, will see their rental yields negatively affected by the government’s new measures for the sector, the majority of landlords (54%) are cash buyers, therefore it is unlikely to alter the appeal of the sector for most. Landlords are, typically, rarely focused on the annual income they receive from their investment with most looking at it as a long-term investment to reap future capital gains. The CML’s survey of private landlords in 2016, the largest of its kind, reported that just 8% of buy-to-let landlords were investing for rental income alone.
Property investment has always been a long-term investment for the majority and acts as a supplement to help boost their retirement nest eggs. Three-quarters of landlords surveyed indicated that capital growth played a part in their reasons for investing in property. Additionally, 70% of those surveyed said that their rental income accounted for less than a quarter of their total income. An average landlord in Great Britain would typically make around £4,000 a year from their property after all taxes and costs have been accounted for. Our data shows that the average landlord typically holds on to their rental home for 17 years before selling up, which is why the extra stamp duty cost has a negligible effect on their return on investment.
With that in mind, it is clear to see why property continues to retain its attraction. Over the last 10 years, it has continued to deliver better total return on investment than other asset classes, almost doubling the returns delivered from both stocks and bonds – returns of 9%, 5% and 6% respectively. This has largely been due to the capital gains, which make up more than 60% of the returns seen, as house prices have continued to grow.
With long-term house price growth still trending upwards, albeit at slower rates than in recent years, the asset class should still be looked on as a valued investment.
|A Changing Environment||Stamp Duty Surcharge||The Changing Landlord||Yields||Rental Forecasts|