Supporting buy-to-let clients in today's market

Buy-to-let has been one of the most significant additional to the UK mortgage market since the mid-1990s. The advent of professional landlords, no longer obliged to embrace commercial lending, has changed the housing landscape of the UK. But it is a market that has grown and evolved almost beyond recognition from its starting point.

How has buy-to-let evolved?

From its birth in the mid-1990s, buy-to-let has undergone many changes. The market now is complex, with a myriad of products, and investors even more so. The private rented sector is characterised by diversity and looks very different now than it did more than a decade ago. The private rented sector is now the second largest tenure in England, and is home to 19% of all households, compared to 14% in 2008-09, when it was smaller than the social rented sector.

Lots of changes in tax mean little spare change for landlords

March’s Budget may have been a damp squib for many voters, but changes to the landlord tax system will have a long-lasting impact and force property investors to make a decision. Chancellor Jeremy Hunt is to abolish the Furnished Holiday Lets (FHL) regime from April 2025 and reduce the capital gains tax (CGT) rate for property sales. Combined, experts say the two changes provide further encouragement to landlords to either leave the market or professionalise their operations.

The market has been in recent times the subject of much regulatory change. Not least in the way landlords pay tax. Stamp duty on additional properties, such as second houses and buy-to-let properties, was increased by 3% in April 2016 and since April 2020, landlords have not been allowed to deduct the interest they pay on their mortgage before paying tax. This gave many higher-rate taxpayers 40% tax relief on their mortgage payments at the time. Many landlords have seen their profits significantly fall as a result. With their tax relief halved, this has been particularly difficult for landlords with interest only mortgages paying higher tax rates.

Landlords also have to declare the income used to pay their mortgage on their tax return, while under the old system, they could declare rental income after deducting mortgage repayments. This apparent income rise may push some up into a higher rate tax band, meaning a bigger tax bill.

Social reform

The Renters Reform Bill aims to change the law about rented homes, including provisionally abolishing fixed term assured tenancies and assured shorthold tenancies; imposing obligations on landlords and others in relation to rented homes and temporary and supported accommodation; and for connected purposes. It forbids landlords from outright barring people and includes several measures to make renting more equitable for tenants. Under the new rules set forth in the Renters Reform Bill, which will also determine the frequency of rent increases, tenants will be entitled to fight unfair increases in rent.

The obligations on landlords should not be underestimated. When letting a property in England, a landlord must:

• Keep rented properties safe and free from the most serious health hazards.
• Make sure all gas and electrical installations or equipment are safely installed and maintained.
• Fit and test smoke alarms and carbon monoxide alarms (where applicable).

Where asked to do so by tenants, landlords also have a duty under the Equality Act 2010 to make reasonable adjustments for disabled people when undertaking a letting. Again, for their most recently let property, landlords and agents were asked which of these requirements they had undertaken.

The cost of money

The market is replete with stories of landlords who have been stung by quickly rising costs of finance but whose tenants are on fixed agreements leaving them with financial holes to fill. Many highly geared landlords have fallen by the wayside. Mortgage interest relief is no longer available, so many landlords have seen their profits significantly fall – in particular, higher rate taxpayers. As they can no longer receive 40% tax relief on their mortgage payments, their tax relief is halved. These changes are particularly challenging for landlords with interest-only mortgages paying higher tax rates.

A greener rental market is still on the horizon

While many may have breathed a sigh of relief that landlords will no longer need to upgrade the energy efficiency of their properties the push for net zero will continue to cost all homeowners money. Lenders are increasingly having to take responsibility for the quality of their portfolios so the pressure will intensify as policy makers bear down on banks to reduce their Scope 3 emissions. The cost of being a landlord is not going to diminish.

Why do investors remain?

Investors in the residential property market benefit in two principal ways. The first is to earn rental income. In some areas of the UK, rental yields are still very attractive. At the same time, investors can enjoy capital growth as property value increase. These drivers have not changed. The undersupply of property generally, and affordability issues means there is still a healthy supply of tenants and demand for private rental accommodation. The terms upon which landlords can participate have changed. As with any maturing market, margins have squeezed.

The advent of the portfolio landlord

In 2016, the Prudential Regulation Authority (PRA) undertook a review of the buy-to-let market and changed the criteria for landlords wanting to borrow money. According to the PRA: “A landlord will be considered to be a portfolio landlord where they have four or more mortgaged buy-to-let properties across all lenders in aggregate”.

The result has been that landlords who fall into this category will now undergo a far more rigorous underwriting process which will include a full analysis of the landlord’s entire property portfolio and it will consider the borrower’s refinancing risk at the end of the fixed period.

The lender will deduct all the property-related costs from any rental income before arriving at a net rental income.

Keeping the right company

Many buy-to-let investors use limited companies to acquire and manage their investments which brings with it various tax advantages, including the fact that corporation tax is lower than income tax. But running these companies is a serious undertaking that brings with it legal obligations and more sophisticated understanding of not only corporation tax but dividends, capital gains tax and the timings of payments to HMRC as well as accountancy fees. It is a route that makes sense for professional landlords, but an individual’s particular circumstances need to be fully understood before embarking on this path.

Knowing your client

Many property investors and landlords have always seen their buy-to-let property portfolio as their pension. This may remain the case, but the expectations of investments and their performance mean the correct decision about which structure will deliver the best returns are crucial.

Buy-to-let might not be the best pension decision for some. Retirement means less not added responsibility. Renting out property means EPC certification, probably a Gas Safety Certificate, tenants constantly wanting things fixed and potential problems with tenants not paying the rent. Yet buy-to-let can provide a steady income from residential rents and the benefit of potential capital lift over time and it is far less volatile than other asset classes. As a long-term investment, where liquidity is not a pressing issue, buy-to-let still takes some beating.

In the current climate of economic, regulatory and political change, every adviser should regularly review their clients' portfolios to ensure their buy-to-let investors are getting value from their properties.