Buy-To-Let

What is residential property investment?

Buy-to-let (BTL or B2L) is the most common residential property investment strategy – purchasing a property and letting it to tenants in exchange for rent. The goal is to receive cash rental payments in the short term, but also achieve capital growth in the long term as property prices increase.

Residential property investors may also use other strategies such as:

Flips – A complete renovation of a property, with the aim to sell the finished property at a profit.
Rent to Rent – Taking on the lease of an entire property and subletting to other tenants for a profit.
BRRR – Buy, Refurbish, Refinance, Rent. Similar to a Flip but the investor retains ownership, and rents to tenants as a buy-to-let.

First time buyers beware

If you are a first time buyer, be aware that a BTL is especially unlikely to be the best way for you to build wealth. The system of incentives and assistance for first time buyers is geared towards helping you buy your own home, not to start a rental business.

As a first time buyer you can use the LISA scheme to get a £1,000 bonus each year of saving for your deposit. This can be used only towards your first home, not a BTL.
First time buyers in England and Scotland receive a one-off stamp duty relief to buy their first home, which cannot be used for a BTL. Additionally, stamp duty is charged at a higher rate on second properties.
As an illustration, to buy a £400,000 home as a first time buyer in England, you would pay £5,000 stamp duty. If you bought a BTL first then sold it to buy your home, you would pay £10,000. If you kept the BTL, you would pay £30,000 in stamp duty.
Many mortgage lenders will not offer BTL mortgages to first time buyers at all, or will have higher deposit requirements for first time buyers.

How does Buy-to-let work?

A buy-to-let investor will purchase or re-mortgage an existing property with the intention to let the property to a tenant. When the rent received from the tenant is higher than the mortgage cost, and other ongoing costs, the investor makes a profit.

Additionally, house prices have historically trended upwards. The difference between the price paid for the property, less the outstanding mortgage, and the current price of the property is where investors can also make money through capital growth.

Active or Passive Investment

In a buy-to-let investment, there are things you must manage before, during and after letting the property to a tenant. Even with a good letting agent, you will need to manage re-mortgages, insurances, and bills during void periods (unoccupied property), organise and review quotes for repairs, submit tax returns, ensure your legal responsibilities are being met, and communicate with tenants or the agent.

Sound like a lot of work? It is. Buy-to-let is not a passive investment.

Buy-to-let Mortgages

In comparison to residential mortgages, which are commonly repayment mortgages, buy-to-let mortgages are usually offered on an interest-only basis, since interest-only mortgages have less expensive monthly payments, so cashflows are improved. However, at the end of the term, the lender will still need to be paid back the initial borrowing amount.

There are some restrictions on buy-to-let mortgages such as the rental coverage, the loan to value and, for properties in personal names, you usually must own another residential property.

Rental coverage ranges between 125% and 150% of the mortgage interest amount compared to the rent received. It is tested at a stressed interest rate, which can range up to 3x the Bank of England base rate. For example, if your monthly mortgage interest was £500 per month, then the lender would expect the rent to be between £625 and £750.

Leverage

By using a mortgage, investors use debt to leverage their property purchases. For example with a £25,000 deposit a bank could loan you up to £75,000, so you could buy a property worth up to £100,000 – more than you could afford to buy/invest in cash.

This leverage is known as the loan-to-value (LTV). Buy-to-let mortgages typically require at least a 25% deposit, i.e. a maximum of 75% loan-to-value.

The reason for this restriction is that leverage is risky. For example, if you purchased a property for £100,000 and the property price increased by 10% then you would make £10,000. However, if the property price dropped by 10% to £90,000 you would lose £10,000. If the property price drops by more than the deposit you have put down, then you will be in negative equity.

Taxation and legislation

Broadly speaking, policy and legislation relating to buy-to-let are becoming more favourable for tenants and there are stricter rules and increased taxes for landlords. It is your responsibility to ensure your legal obligations are being met.

Responsibilities

As a buy-to-let investor, you need to stay informed of changes as these affect your legal obligations and your profits. For example, landlords must perform a gas safety check annually and electrical safety checks every five years.

You are 100% responsible for your tenants’ safety during their rental of the property. Even if you use an agent, the liability remains with you.

How to let

The government has released a How To Let Guide which details many of your legal obligations as a landlord. There are some regional differences across the UK – Scotland has been stricter, introducing landlord registration and additional responsibilities compared to England.

Mortgage interest rate relief

The change to mortgage interest rate relief means that landlords can no longer claim full tax relief on their finance costs (mortgage interest payments, loans and overdrafts).

The tax relief is now restricted to the basic rate of income tax (20%) and is granted on the lower of:

Finance costs – mortgage interest payments, loans and overdrafts.
Property business profits – profits made in the tax year after bought forward losses.
Adjusted total income – income that exceeds your personal allowance.

The tax relief changes have mostly impacted those who are higher earners and also have property income in addition to their salary.

Stamp duty land tax (Transfer of ownership)

This section applies to England only – there are regional differences (Scotland has Land and Buildings Transaction Tax, Wales has Land Transaction Tax).

You may need to pay stamp duty land tax when ownership of a property is transferred. The current threshold for residential property is £250,000 and the rates increase from 5% up to 12% depending on the transfer value. Rates are even higher if you already own residential property, an additional 3% per band!

Limited companies

With the taxation and legislation changes, investors looking to reduce their liability might consider starting a limited company. Transferring residential properties from your personal name to a limited company has additional costs because the stamp duty land tax is due on the market value of the property, not the chargeable consideration.

Other considerations

Emotional and well-being cost

Are you cut out for buy-to-let? From tradesmen to tenants, your patience will be tested. Good management comes down to being organised and motivated.

Tenants are a mixed bag

Be very careful selecting tenants. Do thorough credit and background checks. If you are very unlucky (or lazy in your background checks) you could end up with nightmare tenants. Evictions and court dealings are not enjoyable, are a slow process, and will reduce your profit and willingness to continue with buy-to-let investing.

Buy-to-let Examples

Below is an example buy-to-let property demonstrating the differences between a basic rate taxpayer and a higher rate taxpayer.

Disclaimer: This example is for educational purposes only and does not constitute professional or financial advice.

Our example property is purchased for £100,000 with a £75,000 interest-only buy-to-let mortgage (75% LTV, 5% interest rate over 30 years), with rent assumed at 150% of the mortgage interest payment.

	Basic Rate (20%)	Higher rate (40%)
Gross Income	£5,625.00	£5,625.00
Total Expenditure	£4,805.00	£4,805.00
Net Profit	£820.00	£820.00
Taxable Profit (after adding back interest costs)	£4,570.00	£4,570.00
Income Tax	£914.00	£1,828.00
Interest Tax Relief (20%)	-£750.00	-£750.00
Total Taxation	£164.00	£1,078.00
Cash after tax	£656.00	-£258.00

With expenses and income being equal, depending on if you are a higher rate or basic rate income taxpayer, this property could be either profitable or unprofitable.

This example does not include all costs. Costs can be broken down into one-off or ongoing:

One-off costs

Deposit – usually 25% minimum (so 75% LTV)
Mortgage fees
Legal fees & searches
Surveys
SDLT (England) / LBTT (Scotland) / LTT (Wales)
Estate agent fees

On-going costs

Gas & electrical safety certificates
Repairs & maintenance
Tenancy creation, inventory check-in & check-out, credit & background checks
Buildings & contents insurance
Landlord insurance
Boiler cover
Accounting fees
Smoke & Carbon Monoxide alarms
Fire extinguishers & fire blankets
Void periods (empty property, no income & bills to pay)
Ground rent / Service charges / Factor fees (Scotland)
Letting agent fees

Also excluded from the example are the potential gains, or potential losses, from capital growth. This is the long-term objective of a buy-to-let investment and is often where most of the profits are made by investors.

Can you still make money?

Buy-to-let vs Index Investing

A lot of new investors post in UKPF to discuss buy-to-let and often think it’s ‘easy money’. It’s true that in the past it was easier: lenders were generous, rates were attractive, legislation was looser and taxes weren’t as punitive. Times have moved on and things have changed.

It is important to say that yes, you can still make money with buy-to-let. There are experienced landlords out there with healthy property portfolios that make good returns. We hope the example above demonstrates that buy-to-let is not a ‘get-rich-quick scheme’ and that the cash you actually get to put into your pocket can sometimes be rather underwhelming.

It is widely accepted that index funds are a far simpler introduction to investment for newcomers.

Real Estate Investment Trusts (REITs)

Real Estate Investment Trusts (REITs) are a company, or group of companies, which are a property rental business. The REITs have exposure to the property market because they own a portfolio of properties, which can be residential, commercial or even land.

You can invest in a REIT by buying its shares which are listed on the stock exchange. By buying the shares, you are buying a piece of that property portfolio without all of the hassles of managing it yourself.

This is great for several reasons:

The management team look after it all for you – the REIT is run as a property business.
REITs are exempt from corporation tax – both on rental income and capital gains, which means more dividends for you.
The REIT must distribute at least 90% of its profits.
Dividend distributions are subject to only a 20% withholding tax.
If you buy and hold the REIT’s shares in an ISA you pay no tax on the dividends.

There are many different UK-listed REITs and it can be confusing to choose between them. These days you can pretty much invest in everything through a tracker fund but you should spend some time looking at each REIT and how it invests its capital.