Buy to Let vs Investments

I have recently had a number of conversations with clients regarding the merits of investing their money verses purchasing a buy to let property. Buy to let properties are often thought of as providing better returns whilst having a tangible asset however, with recent changes in legislation, is this still the case? In this article, I look at the merits of Buy to Let vs Investments.

The key changes in tax on Property Investments

There have been a number of changes to the way people who have buy to let properties are taxed as follows:

  • Stamp duty – individuals face a stamp duty surcharge of 3% when purchasing a 2nd home unless they are replacing their primary residence. This would include those who already own one residential property and are purchasing an additional property to rent out
  • Capital gains tax – when selling a property, buy-to-let investors pay higher taxes on capital gains than investors in other asset classes (18 and 28% as opposed to 10 and 20%)
  • Mortgage interest relief – restrictions on tax relief on mortgage interest are being phased in from now until 2020. This will affect the tax relief Higher Rate Taxpayers receive from rental income and may therefore reduce the net income some landlords will receive

Comparing rental properties with other asset classes, there are a number of other changes:

  • Tax allowances on investments and shares mean these are now potentially more attractive such as lower capital gains tax rates and new tax-free allowances on savings interest and dividends
  • The annual ISA subscription limit is now £20,000, enabling investors to build a pot of tax-free assets more quickly (NB ISAs are not free from Inheritance Tax unless invested in AIM shares/Business Property Relief)

Examples

To make a comparison, let’s look at two clients who have £200,000 to invest. Mrs Property purchases a 2 bed property and rents it out, Mrs Investment invests into a moderate portfolio utilising her ISA allowance and invests the rest in OEICs moving into their ISA each year to use their ISA allowance.

What do they each pay?

On Purchase

Stamp Duty

Mrs Property Mrs Investments
The stamp duty on the property purchase will be £7,500, £6,000 represents the additional charge. No stamp duty to pay.

Professional Fees

Mrs Property Mrs Investments
When purchasing a property, people usually use a solicitor and surveyors.   Even without furnishings for the property, these costs are estimated to be in the region of £2,000. For investing with a financial adviser, the advice and set up costs are usually in the region of 3%. The cost of the investment would therefore be £6,000.

So far, the BTL has cost £9,500 on top of the price of the property. Everything being equal, the property will have to return £3,000 more than the investment in order to match the investment.

Ongoing charges

Mrs Property Mrs Investments
Potential Management fees

c10% of income

Maintenance

Mortgage

Tax on rental income

Investments will have ongoing charges levied. The cost is usually a percentage amount based upon the amount invested. The fees include:

·         Ongoing adviser charge

·         Fund management charge

·         Provider charge

On disposal

Let’s assume they both sell after 5 years.

Over the 5 years Mrs Investment has utilised some of her CGT and all of her ISA allowances each year by moving £20,000 from her GIA to ISA each year. At the end of 5 years, she has invested £100,000 into an ISA.

Both the property and investment have grown in value by £50,000.

The property is now worth £250,000 and Mrs Investment has £125,000 in ISAs and £125,000 in her GIA.

Capital Gains Tax

 Capital gains tax on the sale of a second property can be offset with the stamp duty, buying & selling costs and any home improvement costs (normal maintenance such as decorating does not count).

The amount of CGT that applies is as follows:

Mrs Property Mrs Investments
Basic Rate Tax Payer c£5,256 (18%)* £1,370 (10%)
Higher Rate Tax Payer £8,176 (28%) £2,740 (20%)

*The amount may be higher than this if any of the gain takes you into the higher rate tax payer band

There is a really handy calculator on the HMRC website that can help you calculate the tax to pay on the disposal of a property. You can access it here.

Risks of investing in property

There are a number of risks of investing in property which are not always apparent. Some of these are as follows:

  • Falling property prices – although property prices have risen for many years, prices can go down as well as up
  • Liquidity – buying and selling properties takes time, which locks up capital. A forced sale nearly always means accepting a price considerably below market value. If you want to raise some capital, you can’t just sell the bathroom.
  • Lack of diversity risk – for many investors, owning buy-to-lets means that their investments are concentrated in one asset, in one sector (property), in one economy (the UK). A diversified portfolio, in contrast, is typically invested across multiple sectors, industries and countries
  • Void risk – the property may be vacant for extended periods of time which means that there will be no rent to cover any mortgage repayments
  • Maintenance risk – properties need regular maintenance and upkeep – this can be expensive
  • Mortgage risk – interest rates may mean that mortgage repayments increase and reduce the profitability of the property
  • Lifestyle risk – being a landlord can be stressful and time consuming, even for those that employ a managing agent

Conclusion

There are of course risks of investing in assets other than Property – you may not get back as much as you invested, past performance is not a guide to future performance, and fund values can fall as well as rise.

Where it used to be compelling to invest in property, the case is no longer quite so water tight. If you are considering investing in property, make sure you fully understand the associated risks, costs and taxes before doing so. If in doubt, speak to an Independent Financial Adviser or Accountant.

The small print

Tax rules, rates and allowances are all subject to change and are dependent on individual circumstances. The Financial Conduct Authority does not regulate tax advice and some forms of offshore investments. The value of investments and the income from them can fall as well as rise and you may not get back the full amount you invested

 

2 Comments on “Buy to Let vs Investments”

  1. Very useful Alice thanks. I have been considering a buy to let for some time. From this information, I think I’ll keep the money in my ISA!

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