The Budget has been set and the Chancellor will not be reversing the mortgage interest tax relief changes expected to come into effect next month, with many reacting to this by saying that the heady easy money days of buy-to-let property investment are well and truly over.
But is this really the end of the buy-to-let property dream?
We recently attended the Landlord Investor Show, where Paul Mahoney of Nova Financial gave an interesting talk on whether property can still be profitable in 2017. So before you believe the headlines, let’s take a look the numbers…
Cash, stocks or property – comparing assets
When you look at the performance of property compared with other asset classes, it’s actually quite incredible what leverage property can do, returns wise.
Paul stated that he sees property as the best asset class for achieving financial success – and part of the reason for that is this ability for leverage. He went on to explain that what separates property as an investment asset versus things like shares or other types of investments, is the ability for high levels of debt at low interest rates, over the long-term – and there’s not really any other investment asset you can do that with.
In other words, if you’re taking a 75% mortgage, you’re timesing your returns by four. And as long as you’re covering the mortgage repayments over and above what the costs are, the ability for returns is accelerated.
As safe as houses?
Another benefit of holding property is the fact that it’s stable and reliable. As Paul 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 assets!
Some people see the high entry and entry costs with property as a negative because it’s not very liquid, but actually this tends to result in stability. There are also lots of different types of property offering different types of returns, and this diversification is also a positive thing.
But most importantly, property produces fantastic returns – and you really can’t dispute the numbers…
The graph Paul highlighted during his talk is based upon a report from 2013, titled ‘Buy-To-Let Comes of Age’, commissioned by Paragon Mortgages and done by Wrigglesworth, the research house. The reason it was called Buy-To-Let Comes of Age was because in 2013, buy-to-let mortgages had been available for 18 years – and therefore became adults!
The graph looks at a 75% leverage buy-to-let property, over that 18 year period, and the returns on the cash applied, (so a £100,000 property and the returns on the £25,000 applied). As you can see from the graph, the average return on that cash, over those 18 years, was a staggering 16.3%.
So let’s say you invested £1,000 18 years prior to 2013, that £1,000 would be worth £13,000 – which is an incredible 1,300% return on your cash. And that number is achieved through an average of about 5.4% growth and around a 2% net yield after all costs.
Paul pointed out that these numbers – 5.4% and 2% – are by no means an over achievement, but the average UK wide numbers. Instead, the reason for the great returns is the leverage. When you times those figures by four, that’s how 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 as safe as houses in 2017?
Brexit has left the economy in a state of shock, house prices have been targeted and there has certainly been short-term confidence wobbles that have hit the property market in London.
Many will be quick to say that the graph above shows buy-to-let property when it was in its boom, and the same returns can’t be available in today’s market. It’s important to remember that over that same period in the graph above we experienced the one of the biggest market collapses in this generation in the summer of 2008, with UK house prices plummeting by around 16%.
The emphasis of this article is that property is a long-term game, and over a 10 year period it’s completely natural for the market to have its ups and downs. Currently we may be in a dip, but we do expect the market to smooth out. After all, the population is rapidly growing, demand for housing in London is stronger than ever, and yet we’re suffering from an acute housing shortage. Until the lack of housing is addressed, rental prices and property prices will remain sky-high.
So in short, the answer is yes, property is still as safe as houses. Yes – you’ll now pay an extra 3% stamp duty, for example, but when you’re looking at these sorts of returns, it’s still easy to account for as you’ll get it back in less than a quarter.
Worked examples according to the new tax changes
Paul went on to talk about cash flow analysis, and gave two worked examples which account for all the recent tax changes.
Quick Example: lower rate tax payer (pink) and higher rate tax payer (blue).
The first set of numbers is a quick example of someone earning less than £50,000 per annum, who is on the basic rate of tax. The second set of numbers is for someone earning more than £50,000, so they’re on the higher rate tax band. Both bought property in their personal name.
The example uses a £350,000 property, with a rental yield of 4%, a capital growth rate of 5.5%, (which is about the average for the past 20 years), over a 10 year period, with a 75% mortgage and an interest rate of 3.5%, (which is about 1-1.5% higher than what’s achievable today). The example also uses a 20% tax rate as the person is earning less than £50,000 a year.
As you can see, the post-tax return they will achieve is £233,000 or a 237% return on their cash. Of course this is for someone who’s earning less £50,000, so they are not really affected by the tax changes being implemented in April, asides from the extra stamp duty.
So now let’s look at a detailed worked example for someone who is earning more than £50,000 a year; Paul pointed out here to remember that this is the person who the papers are saying property investment will no longer work for.
Using all same figures as above, the only difference is the tax rate change. Stamp duty for basic rate tax payers is: sale price less purchase price less capital costs less £11,000 yearly allowance multiplied by 18%, and stamp duty for basic rate tax payers is: sale price less purchase price less capital costs less £11,000 yearly allowance multiplied by 28%.
The table shows from now through to 2020 when the tax changes are fully implemented, and the 6 years after that when they’re in full effect for the 10 year period. They’re still making £212,000 and a 216% return on their cash. And though the example is hypothetical and based upon fairly average returns UK wide, a 4% yield and 5.5% annual growth is still achievable in London if you choose the right property in the right area.
Paul interjected here to say he doesn’t know of anybody who would say a 216% return over 10 years is a bad return – and we’d have to agree with him, especially as these are pretty average drivers.
The most important thing to remember is that property investment is a long-term game. Yes, the lucky few may make huge gains within short time periods through property renovation or buying below market value, but generally the longer you hold a property, the more rental income you’ll receive and the higher chance you have of selling for a higher price than you paid.
If you want to make a good profit however, there are a few 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 property, cut your interest costs by re-mortgaging and getting an up to date rental valuation on your property. 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, it’s smart to diversify your property portfolio and buy a range of property in a range of up-and-coming areas. Check out our Interactive Yield Map to find out where to find the best investment hotspots in London. Thirdly, add value to your property in any way possible, whether that’s through renovation or keeping it in good condition and contemporary in style.
And finally, you’ll never make huge money from property if you have to pay the taxman more than you absolutely have to. With the new mortgage interest changes coming into effect next month, it’s now more important than ever to have a good accountant.