The Budget has been set, and the Chancellor did not reverse the mortgage interest tax relief changes for landlords due to come into force next month. Many are worried that this means the days of achieving wealth through buy-to-let property are over.
But is this really the end of the buy-to-let dream?
Paul Mahoney, of Nova Financial, recently gave a talk on whether property can still be a vehicle for achieving wealth in 2017. So, before you give in to the headlines, take a look at the figures…
When you analyse the performance of property compared with other asset classes, it’s quite incredible what leverage property can do in terms of returns.
Mahoney considers property as the best asset class for achieving wealth, and part of the reason is the ability for leverage. He explained that what separates property from assets like shares is the ability for high levels of debt at low interest rates over the long term – and there’s not really any other asset class that you can do that with.
For example, if you take out a 75% loan-to-value (LTV) mortgage, you’re multiplying your returns by four. And as long as you’re covering the mortgage repayments over and above what the costs are, the ability for strong returns is accelerated.
Another benefit of holding property is the fact that it’s stable and reliable. As Mahoney pointed out, not many people go out and sell their property when they see on the news that China is having economic issues, but they may well do with other asset classes.
Some people consider the high entry costs with property as a negative because it’s not very liquid, but this actually tends to result in stability. There are also many different types of property offering various returns, and this diversification is also a good thing.
But, most importantly, property produces fantastic returns – you can’t really dispute the numbers…
This graph, titled Buy to Let Comes of Age, commissioned by Paragon Mortgages, was so named because, in 2013, buy-to-let mortgages had been available for 18 years.
The figures look at a 75% leverage buy-to-let property over that 18-year period, and the returns of the cash applied (so a £100,000 property and the returns on the £25,000 applied). As you can see, the average return on that cash was a huge 16.3%.
So, imagine you invested £1,000 18 years prior to 2013, that money would be worth £13,000, which is an incredible 1,300% return on your cash. That number is achieved through average growth of 5.4% and a 2% net yield after all costs.
Mahoney highlighted that these numbers – 5.4% and 2% – are by no means an over-achievement, but are the averages for the UK.
Instead, the reason for the great returns is the leverage. When you multiply these figures by four, you get to the 16%. In comparison, cash property was at a 9.7% return, commercial property at 7.9%, FTSE Share Index at 6.8%, gilt at 6.5% and cash at 4%.
Is property still safe?
It’s true that Brexit has left the economy in a state of shock, with short-term confidence wobbles hitting the property market.
Many will be quick to say that the graph above shows buy-to-let investment in its boom and the same returns cannot be achieved in today’s market. However, it’s important to remember that over that same period, the country experienced one of the biggest market collapses in this generation in the summer of 2008, with UK house prices plummeting by around 16%.
Mahoney emphasises that property is a long-term investment and, over a ten-year period, it’s completely natural for the market to have its ups and downs. Currently, we may be experiencing a dip, but the market is expected to smooth out. After all, the population is rapidly growing, demand for homes is stronger than ever, and we’re suffering from a chronic housing shortage. Until the lack of homes is addressed, rents and house prices will remain sky-high.
And, although you’ll now pay an extra 3% in Stamp Duty, it’s still easy to account for, as you’ll make that money back in less than a quarter.
Worked examples based on new tax changes
Mahoney went on to discuss cash flow analysis and gave two worked examples that take the new tax changes into account.
The first set of numbers is for someone earning less than £50,000 per year, so is on the basic rate of tax. The second is for someone earning more than £50,000, so they’re on the higher rate. Both purchased property in their personal name.
The examples use a £350,000 property with a rental yield of 4% and a capital growth rate of 5.5% (which is around the average for the past 20 years) over a ten-year period, with a 75% mortgage and an interest rate of 3.5% (which is about 1-1.5% higher than what’s on offer today). The first example uses a 20% tax rate.
As you can see, the post-tax return this person will achieve is £233,000, or a 237% return on their cash. Of course, this is for someone who’s earning less than £50,000, so they aren’t likely to be affected by April’s tax changes.
The following example is a more detailed look at someone earning more than £50,000 per year. Mahoney pointed out that this is the person that the headlines are saying buy-to-let will no longer work for:
Using all of the same figures, the only difference in this example is the higher tax rate.
The tables show numbers from now through to 2020, when the forthcoming tax changes are fully implemented, and the six years after that, making a ten-year period.
This investor still makes £212,000 and a 216% return on their cash. And though the example is hypothetical and based upon average returns for the whole of the UK, a 4% yield and 5.5% annual capital growth are still achievable if you buy in the right areas.
Mahoney interjected to say that he doesn’t know of anybody who would say a 216% return over ten years is bad.
The most important thing to remember is that property investment as a vehicle for achieving wealth is a long-term game. Typically, the longer you hold a property, the more rental income you’ll receive and the higher change you’ll have of selling for a higher price than you paid.
If you do want to invest for achieving wealth, however, there are some big dos and don’ts:
Firstly, never put yourself in a position where you are forced to sell your property. Make sure you take advantage of record low interest rates or, if you already own a property, cut your interest costs by remortgaging and getting an up-to-date rental valuation on your investment. Your lender will therefore have to recalculate your LTV, and a lower LTV ensures a better interest rate and a larger selection of lenders.
Secondly, you should diversify your property portfolio and buy a range of properties in various up-and-coming locations.
Thirdly, add value to your property in any way you can, either through renovation or modernising the style.
And, finally, you’ll never use property for achieving wealth if you pay more tax than you need to – with the new tax changes coming into effect next month, it’s now more important than ever to meet with a finance expert.
If you do decide to continue investing in buy-to-let, remember to take out award-winning Landlord Insurance from Just Landlords: https://www.justlandlords.co.uk/landlord-insurance