Is Buy-to-Let Still a Good Investment?

Bloomberg Audio Studios. Podcasts. Radio. News. Welcome to Merrin Talks Your Money, the personal finance edition of Merrin Talks Money. In these bonus podcasts, we talk about the best strategies for making the most of your money. I'm Merrin Somerset Webb, editor-at-large for UK Money. Now, this month is important. Well, important for those of you invested in property anyway. It marks the 30th anniversary of the creation of the buy-to-let mortgage, a new type of home loan that triggered an explosion of rental activity in the UK when it launched. But thanks to regulation and tax changes, I mean a lot of regulation and tax changes, being a landlord isn't quite as appealing as it once was. Well, that's my view anyway.

Other people may have different views. So this week, we're going to talk about how buy-to-let mortgages reshaped the face of property investment in the UK and whether it has a future of any kind. Joining me today is the head of research at Hampstead International, Anisha Beveridge. Hampton's has just put out a report on 30 years of buy-to-let. Anisha, welcome to Merrin Talks Money.

Thanks for having me, Merrin. Right.

It's been quite a ride, buy-to-let, hasn't it? Can we have a little potted history? What is it that happened back in September 1996? Well, I think.

It was 1996 when the first kind of buy-to-let mortgage launched that really kind of kick-started the growth in the rental sector and has really built the foundations of what we see in that market today. Before that time, landlords or anyone that wanted to buy rental properties had to either buy that property outright with cash or or they had to kind of rely on commercial loans, which tended to be pretty expensive in terms of interest rates, were only available on kind of 10-year maximum terms. So it wasn't the most kind of costly way of approaching an investment.

But the use of kind of a buy-to-let mortgage, using leverage, and importantly, banks started using rental income as a way of assessing affordability. And that really opened the doors to a bigger kind of group of investors.

And you could also get interest-only mortgages, couldn't you, in the buy-to-let business even then?

Yeah.

So you could put down a small deposit, huge leverage, and then rely on paying an interest-only mortgage off from the yield and then assuming that inflation would mean that the remaining mortgage was worthless or negligible 30 years after that. Yeah.

And of course, I think it was interesting, actually, because back then, when we look at some of the numbers, the majority of the buy-to-let mortgages that were taken out in the late 90s were actually repayment mortgages, not always only. But of course, it was an era of very rapid house price growth. And we were seeing sort of 20%, 30% year-on-year growth in times in the late 90s. And all of a sudden, house prices doubled within a kind of six-year window. And it just built in the ability for people to use that equity and kind of build portfolios from then on.

So the way you say that suggests that over time, the majority of the return to investors in buy-to-let has been from capital gains. But looking at the report, that's not what you say at all. You say something completely different, that the majority of the long-term return has been from rental income.

Yeah. So when we look over the full 30-year period, around two-thirds of investors' typical kind of total return has come from rental income. We split that period in half and you look at the first sort of 15 years leading up to the financial crash and generally we saw very strong capital growth. Whereas over the last 15 years, we've generally seen rents outperform house price growth. So those kind of balances, the scales have very much switched during that 30-year period.

Yeah, because initially you were saying that the very fast house price growth in the late 1990s and early 2000s, at that point, for a lot of people, it didn't really matter if you had positive cash flow. You only had to break even. You only had to break even and nothing else really mattered because the capital gains made all the difference.

Yeah, absolutely. And I think that's the way that people looked at it. They were betting on house prices continually rising. They weren't so worried about the rental income. And it's why so many of them were actually on repayment rather than interest-only loans as well. That was capital growth because of what they had sort of seen the value.

Of their own properties.

That was where they were hedging their bets.

Yeah. Well, we'll come on to how and why that switched in a minute. I just wanted to ask you about, there's a wonderful chart in the report. We'll put it in the show notes and link to the report, which suggests that every £ 1 invested in 1996 is worth £ 22. 30 today. Absolutely marvellous. It outperforms absolutely everything. But what are the assumptions in there that assumes what level of deposit, what level of loan, et cetera? How does that work?

So we've basically tracked what's happened to rents and house price growth over that kind of 30-year period. And we're assuming that everyone reinvests their money and any dividends are reinvested when we're comparing it to other assets as well. I don't think we've taken mortgage costs into account here, but what we have taken into account is broader costs.

And we can see from HMRC that the typical landlord essentially offsets around a third of their rental income every year. in costs. And that's what we've accounted for throughout this period. And of course, costs associated with buy-to-let tend to be quite a lot higher than some of the other assets that we're comparing to.

Yeah, I suppose my question was that this assumes that the buy-to-let investor has a mortgage.

Yes.

So it's a difficult comparison because you're not allowed to borrow £ 250, 000 to invest in. You could if you, but you can't actually borrow against investing in the same way. You can't borrow to invest in the FTSE 100 or the 250, et cetera. So it's very different. I get the comparison and it's very useful, but it's a bit apples and oranges.

Yes, exactly. It's the use of leverage really that kind of makes buy or has made buy to let so appealing over. And that's really what coming back onto that 30 years ago when they launched the buy to let mortgage, that was probably one of the number one appeals of it.

If you'd been able to have 80% leverage in the. In the S & P 500, that would be quite something on the chart.

Yeah. Right.

Let's look then at what changed. So there was a lengthy period post-1996 when you were really, really, really accruing capital gains and you weren't that fussed about your cash flow. It wasn't really a big deal as long as you weren't having to pay into the thing. Nothing really mattered because you were making tens of thousands of pounds every month, every year in capital gains. But then there came a point, didn't there, where things began to change when house prices stopped going up so fast and the tax regime changed and suddenly cash flow began to matter.

Yeah, absolutely. I mean, we obviously went through the kind of 2008 financial crash where property prices fell and they fell quite rapidly in the UK, particularly in London, which was where a lot of the buy to let investment had been focused, I think. But then sort of since then, it was really kind of George Osborne back in 2015 time that started to kind of knuckle down on buy to let, the regulation and taxation of buy to let.

And I think there was this kind of consensus, wasn't there, that all of these buy-to-let landlords were pushing out first-time buyers. And in some cases, I think that's probably true, but not across the board from what we can see in the numbers. And that's when he started introducing a 3% stamp duty surcharge on second home purchases and announced the tapering of this mortgage interest tax relief. And that was one of the big, big factors that really started to kind of dent profitability of buy-to-lets.

And how does that work? So previously, you could offset your mortgage costs against your income, regardless of what your marginal income tax rate was. But the change meant that it was only a 20% tax credit. So you could only do it at the lower rate.

Yeah, absolutely. And what that kind of meant in reality was that if you were a lower income taxpayer, you didn't really see too much kind of change because you still had that 20% tax credit. But if you were a higher rate taxpayer, it became quite painful. And it also started to mean, in some cases, it pushed landlords into that higher income tax bracket. And at other times, it meant that you could actually be paying a tax bill, even if you made a loss profitability wise on your buy to let. So that was quite a big change in the way that landlords were taxed. And it's also one of the reasons why we've started to see so many landlords move towards limited companies as their operating structure of choice for buy to let.

Okay, so you get to a point where if you don't move it into a limited company, it's possible that your cash flow goes negative, but you still have a tax bill. And at the same time, you're not making capital gains in the way that you were previously. In fact, across a lot of the UK, obviously, you're making capital losses at the moment. And so everything begins to change.

But how did it work? Or how does it work to move it into a limited company structure?

Well, it's a fairly simple thing to do from an accounting perspective, but there are other costs involved. So you do have to kind of file annual accounts. Generally, that needs a proper accountant to do that. But some of the big costs with moving properties into a limited company, if you already own them in your personal name, is that you pay stamp duty on that transfer, which, of course, can be quite painful. You pay that 3% surcharge as well.

And you are also potentially liable for capital gains tax if you have made a gain on that property purchase as well. So the costs associated with moving property across can be quite painful. But equally, people are doing it. And we can see that in the numbers. We've seen sort of record numbers of new buy-to-let companies set up.

The numbers are starting to slow a little bit this year. And that's because we think so many people have decided to take a long-term view and move those properties into those LTD structures.

Are you seeing many new buy-to-let landlords coming into the market? I mean, in the old days, everyone wanted to be a buy-to-let homeowner, and you had lots of young people doing it, and you also had the accidental landlord, people who were owned two properties, for example, and they'd get married, they'd buy another one, and they'd leave their old flats as buy-to-let investments effectively. We call them accidental landlords. So pretty much everyone wanted to get into this. And that was a perfectly normalized and common thing to do. But is it still? Do you see new people coming into this market?

I think it's completely changed, to be perfectly honest. And that's one of the biggest shifts we've seen in the rental sector over the last sort of decade or so, Investment has to be far more targeted now. It generally has to be yield-focused, particularly if you are using a mortgage to purchase that property because you can't rely on capital gains like some of the older landlords were able to do so. People are still investing. Around just under 10% of all homes sold so far this year were purchased as buy-to-lets. That figure's come down from around 16% a decade ago, so we've definitely seen a decline. But people are starting to change what they buy, where they buy to try to kind of make the sums work. And

people are achieving that. But it's generally those kind of full time, more experienced landlords with bigger portfolios who are still in the sector today.

Interesting. So what kind of thing are they buying that will give them that higher yield you're talking about?

Well, a lot of people are focusing further in the north of England, which tends to have better yields on offer. So, for example, the northeast is the highest yielding region in the country and gross yields there on new buy-to-let purchases are averaging around 9.8%, so just under the 10% mark, which can look quite appealing even when you strip some of the kind of costs back. London has typically been the lowest performing region from a yield perspective for since our records began. But because we're starting to see or we've been seeing house prices fall there and quite considerably in some of the prime markets, we are starting to see sort of tentative signs of a few investors trying to come back in. And they're, again, doing a sort

of cash play, relying on the fact that capital growth might pick up in the next couple of years and we'll see a recovery in that market. So, yeah, that's a sort of fairly preliminary thing that we started to see over the last kind of nine or so months in London.

Very optimistic of them. Is there more regulation or more taxation coming, do you think, in that we know that the government seems to be relatively anti-existing homeowners and there's talk of mansion taxes and changing council tax bands, et cetera. Obviously, that is focused at the top. But nonetheless, I wouldn't be surprised to find them trying to come up with another way to go after landlords. Can you see anything else that might be of concern?

Well, it feels like nearly everything's been thrown at landlords over the last decade, doesn't it? But I don't think if you are thinking about investing, you've got to kind of weigh up the fact that there might still be more. Generally, our kind of view is that the way that limited companies are structured gives you a bit more sort of scope to kind of get around some of the more targeted tax measures that might still come down the line.

There are still rumours about landlords having to pay additional sort of paying national insurance, for example, on their rental income, which I think was rumored by Rachel Reeves around a year ago and got ruled out. So whether we'll see that come in, it feels unlikely, but it is a possibility. So there is still more to come, particularly still around the Renters' Rights Act, energy performance regulations, all of those sorts of things too.

Indeed, there was things that didn't exist back in 1996. So I mean, regulation is expensive as well. So when you talked earlier about new buy-to-let landlords or the buy-to-let landlords who are still buying, being older, more experienced means they've taken on this regulation bit by bit as they've gained experience in the industry. It would be hard to come in new to it and pick it all up in one go.

Yeah, and I think that is definitely one of the bigger barriers to entry nowadays is you really have to know your stuff because some of the fines now associated with not doing your job properly as a landlord are pretty hefty. So what we are kind of seeing very much is this professionalization of the private rented sector. And most landlords now will either lean on a managing agent so that they hopefully tick more of those boxes and get a bit more advice. Or sometimes if they've got big portfolios, we'll even have teams beneath them to to make sure that they are complying and getting things right.

But yeah, you really do have to know your stuff nowadays.

Yeah. And I would also say that perhaps with the renter's right, et cetera, and the difficulty you might have with evicting anybody or troubles with people not paying their rent, et cetera, et cetera, you may feel that you need a portfolio rather than just one property. You need to be much more diversified than maybe you did 30 years ago.

Yeah, I completely agree. I think economies of scale pay off in these scenarios, don't they? So But diversification is really important as well. And there are certainly ways to do that within buy to let by buying different property types, buying in different regions, that sort of thing. And I think, again, that's a sort of behavioral change that we have seen kind of investors take on over the last 10 years or so. They are thinking more actively about that sort of thing.

Okay. So top tips for anyone wanting to get in now, head north for Yield. be optimistic about capital gains going future, be diversified, understand the regulation. Anything else? What about mortgage rates? Presumably they have been heading up. How do you get the best possible rate?

Yeah. Mortgage rates are very unpredictable at the moment, aren't they? Which isn't helping, but you do have the ability to lock in early with some of these kind of buy to let offers and sort of spread your risk in that manner. So I think that's certainly something to think about. But For me, the number one crucial tip is really understand the market that you're buying into. More often than not, it's the purchase price of a property that really then dictates the performance of that asset longer term. So don't overpay for something. Do your research. Make sure that you're buying something at what you deem is a good price.

And it has rental kind of prospects or you've already thought about where the demand your tenants are likely to come from. And that's kind of how you future.

Proof it really. And choose your tenants carefully.

Choose your tenants very carefully nowadays. Referencing is an absolute must. There's a whole raft of new insurance products that have come out over the last year from the Renters' Rights Act. And it sounds like they'll do their job. But a lot of that we're still kind of waiting to play out and to be seen. It's all fairly new still, isn't it?

Insurance products for what? Insuring you against people not paying rent insurance? Yes.

Yeah, exactly. So not paying rent, any sort of, if you have to kind of go down the court route, kind of cover legal costs, things like that. We think we're going to see a lot more landlords turn to products like that just to sort of mitigate risk and have a bit of a backup. Okay.

Interesting. I didn't know about that. Fantastic. Brilliant. Thank you very much. Any more top tips? Are we at the end of top tip world here? That was a lot. Those are tips. Brilliant. Personally, I'm not going to become a buy Gillette landlord in a hurry. You?

Probably not at the moment, but I think there could be some scope in a couple of years' time, potentially.

Okay. Watch this space. We'll get you on again when you think it might be time. Thank you very much for joining us today.

Thank you.

Thanks for listening to this week's Merrin Talks Money. If you like our show, rate, review and subscribe wherever you listen to podcasts. Also be sure to follow me and John on X or Twitter at MerrinSW and John underscore Steffek. This episode was hosted by me, Merrin Somerset Webb, produced by Summer Sardi, Jennifer Celia, Moses Andam. Questions and comments on the show and all our shows are always welcome.

Our show email is MerrinMoney at Bloomberg.net.

Is Buy-to-Let Still a Good Investment?

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