DO THE SUMS

STILL STACK UP?

Property has outperformed many other assets over the long term, and with interest rates at historic lows, yields on alternative investments are thin. Yet, with all the extra obstacles the government has thrown its way, is housing still an attractive investment?

Gross versus net yields

Gross yields, expressed simply as annual rental income as a proportion of the property value, are typically at the forefront of talk about the attraction of a rental investment. But as they do not take into account the many additional costs and taxes now associated with buying and owning a rental home, they do not reflect the true return. Net yields , which consider the expenses associated with owning a rental home and the taxes landlords must pay, provide a more accurate picture.

Impact of costs and taxes on yield

From the 2020-21 tax year, an average mortgaged landlord in Great Britain who’s a higherrate taxpayer with a 75% LTV interest-only loan on a property bought for £190,000 will see their net profit (i.e. after tax and costs) fall from £4,303 in 2016-17 to £3,720. Despite them no longer being able to offset all mortgage interest against tax, crucially they are still able to return a profit. A basic-rate taxpayer will not see any change to their net profit of £5,740 a year.








 

However, if we assume landlords incur additional costs representing 10% of their rental income, the average higher-rate taxpayer will see their net yield fall from 2.3% to 2.0% over the same period. However, it’s worth remembering that flats, whilst commanding premium yields, often have higher costs associated with ownership, such as ground rent and service charges. Also, most investors aim to recover stamp duty through capital growth, but even if this is added to the purchase price, a higher-rate taxpayer landlord can still return a net yield of 1.9% in year one. A lower-rate taxpayer would see their net yield fall from 3.0% to 2.9% with stamp duty added.

London landlords, who have bigger mortgages in absolute terms, are set to be hardest hit by Section 24 tax changes. The average higher-rate taxpayer landlord in the capital will see their profit fall by 20% to £6,040 a year. London also has the lowest gross yields in the country, so once costs and tax are factored in, the average net yield for a landlord here will fall to 1.2%.

Capital growth

While higher-rate taxpaying mortgaged landlords, both new and existing, will see their buy-to-let profits shrink because of the tax changes, the many landlords who own their property in cash will be unaffected. While yield from rental income is still important to cash landlords, many look for capital gains to drive their total return over the longer term.

The average landlord who sold up last year sold their buy-to-let for £78,010 more than they paid for it, having owned it for an average of 9.2 years. After maintenance or improvement costs (we’ve assumed 20% of the gross return), and when stamp duty and capital gains tax are added, the average 40% taxpayer landlord in Great Britain made a net profit of £43,340 after selling.

In London, this figure rose to £154,600 due to the region recording the strongest house price growth over the last decade. For many landlords in the capital, stronger capital growth has made up for weaker rental income as a proportion of their property’s value.

Total returns

Once rental income and capital growth over the average nine-year ownership period are added together, the average landlord in Great Britain made a total net profit of £76,820 in 2020. This represents a 39% return on their initial investment, or an annual net yield of 4.3% after costs and taxes.

London landlords made the biggest absolute total profits, averaging £208,930, or 4.5% each year, with 80% of this generated from capital growth. While landlords in the North West earnt the second highest annual total net yields of 4.4%, 57% of their profits came from rental income and
43% from capital growth.

All this means that while the focus on rental income is becoming increasingly important for mortgaged landlords, capital growth should not be underestimated. And while net yields have shrunk, particularly for higher-rate taxpayers, in most cases buy-to-let remains profitable.


 

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