Buy to let properties are usually considered a safe and steady investment. But recent changes to government policy and regulations have meant decreased profit margins for some landlords. 

Buy to let landlords can profit from their investment in two main ways: from rental income and by capital growth – selling their property for more than the price they paid to buy it. 

Rental income can provide you with an additional monthly income – or you could reinvest the cash or use it to build up a pension fund or an ISA. 

But some investors have found their rental profits seriously diminished following cuts to income tax relief. 

You can also make a significant profit or add a major asset to your net worth if you’re savvy about the type of property you buy and when you buy. 

Here at Yuvoh, we’ve found the main things you should think about when deciding if buy to let investments are right for you.

Making a profit

Your rental income will mostly depend on location of your property and the type of tenancy you offer.

Long Term Lets

Long term tenants will typically be families or a group of friends under Assured Shorthold Tenancy agreements (ASTs). Landlords can often get an annual revenue of 5% of the value of the property if they have tenants throughout the year.

  • Rent is highest in city centre locations
  • But suburbs and newly-developed areas can be the most lucrative compared to the value of the property if demand for homes to rent is higher than demand for homes to buy.

The rent you charge will have to match the rates of similar properties in the area because it’s easier than ever for tenants to compare rents online. Competition for long term tenancies is high for landlords as well as tenants, but a property that is newer and has better furnishings and conveniences can give you an edge.

Short Term Lets

Short term lets can be tenancies for just one night or up to six months. Your rental income depends on how much you charge and how often you have tenants in your property.

  • Annual rental income can be 10-20% of the value of the property – often double or more what the same property would produce under a long term tenancy
  • Rental income tends to be less regular
  • City centre properties are always in high demand. Your tenants could be visiting for the weekend or temporary contract workers staying for a few months.
  • As a rule, the shorter the stay, the more your tenants pay per night.
  • Homes in popular holiday destinations are finding increasing demand from tourists as more and more Brits take holidays in the UK.

Capital Growth

Capital growth for your property is harder to forecast as house prices vary by the fluctuations of the economy. No one can predict with certainty how much your property will be worth in any given year. House prices in the UK have been increasing over the past few years, but past rates of increase are not a reliable indicator that they’ll continue to rise.

Generally speaking, however, the longer you have it, the more opportunities you’re giving yourself to sell when property prices are high and make a bigger profit.

Costs

When you’re buying a property, you’ll be paying for more than just the asking price of the property.

Upfront costs

  • Deposit: You can get a mortgage to pay for most of the property price. Most buy-to-let mortgages offer 60-75% loan-to-value – this is the percentage of the total property price that the bank lends you. You’ll have to provide the remaining 25-40% as a deposit yourself.
  • Mortgage fees: Lenders often also charge a one-off fee when you accept their mortgage offer. These can be £1-2000 or a percentage of the amount you are borrowing. They’re sometimes also called ‘deal fees’ or ‘arrangement fees’.
  • Solicitors fees: you’ll need to appoint a solicitor to handle the purchase of the property once the seller has accepted your offer. Solicitors can charge £2000-£3000 for their services.
    They will also conduct searches and a survey to ensure the property can be legally sold and is in a habitable condition. These can cost about £500-£1000.
  • Stamp duty: Stamp Duty is a tax paid when you buy a second home. The amount you pay is a percentage of the price of the property – typically 5-8%.
  • Renovations: renovation costs will depend entirely on the condition of the property. A brand new property may be ready for tenants without any renovations, while older properties might need essential repairs or redecorating.

Ongoing costs

  • Maintenance and Repairs: landlords are responsible for some repairs while the property has tenants, but these vary by the property and how it’s used. Older properties tend to cost more in repairs because older appliances might break down and structural issues like damp can crop up, while you might be able to let out a brand new property for several years without any repairs or refurbishments
  • Service charges: homeowners in apartment blocks usually have to contribute to the costs of running of the building as a whole. This is usually a flat rate paid every month or year.
  • Insurance: buildings insurance or home insurance cover damage to the property and the fixtures. It’s best to also take out a landlord insurance policy, which can cover your losses and legal costs if tenants stop paying rent or damage or steal your property.
    There are a variety of different coverage packages available, and some insurance coverage may be mandatory by your mortgage provider.
  • Utilities: the landlord covers electricity, gas, water and broadband bills for HMOs and short term lets. These will vary by the property and how much your tenants use.

Selling costs

To ensure you make a profit when you sell, the sale price needs to cover how much you paid for the property in the first place, and selling costs such as agency and solicitors’ fees and the capital gains tax.

If you sell through an estate agent, they’ll take a fee of 1% to 3% of the sale price of your property.

You’ll also need to appoint a solicitor to sell. Their legal fees can be from £500 to £1000, and you may have to pay another £500 in searches and Land Registry fees.

The biggest cost when you sell is Capital Gains tax. This can be 18% or 28% of your profit, although there’s an £11,700 allowance. It has to be paid in full at the end of the tax year. We explain this more fully below.

Tax

Your investment is taxed in a few different ways: you’ll pay income tax on the rent you receive, stamp duty when you buy the property and capital gains when you sell.

The government has recently increased the stamp duty for second homes and has reduced the income tax relief for buy to let landlords. This can cut into your profit margins.

Income Tax

The rental income you receive from tenants in your property is taxable. This is added to your total annual income and taxed according to the UK tax rates – so your rental income might push you up into a higher tax band. You’ll have to file a Self Assessment tax return every year with the HMRC. The HMRC will then get back to you with a tax bill.

Some of the costs involved in your property investment, such as repairs and insurance, will count as expenses and won’t be included in your total income.

Buy-to-let investors also used to get full tax relief on all interest payments for their mortgage – so you were only taxed on the profits after you deduct interest payments and other costs from your rental income. This is now being limited to Basic Rate tax relief – so only 20% will be deducted from the tax rate you pay for the rental income that you spend on interest payments.

Stamp Duty

Buyers have to pay a tax on any property that costs more than £125,000 in the UK. This is paid on the same day that you complete the payment for the property itself. If it’s your second property, 3% is added to the tax rate and any property over £40,000 is taxed.

The tax rate is calculated according to tax bands for the property price. There’s a tax free allowance of £40,000 for your second home or a buy-to-let property. You’ll then pay 3% for a property up to £125,000, 5% up to £250,000 and 8% up to £925,000 of the purchase price.

For example

You buy a house for £350,000. It’s the second property you own and you’ve bought it as a buy-to-let investment.

Tax band Taxable amount What you’re paying Calculation Stamp Duty paid
Up to £40,000 £40,000 Tax-free allowance: nothing to pay £0
£40,000 – £125,000 £85,000
(£125,000 – £40,000)
3% on the next £85,000 of the property price.
This takes you to the £125,000 threshold (second property surcharge)
£85,000 x 3% £2,550
£125,000 – £250,000 £125,000
(£250,000 – £125,000)
5% on the next £125,000 of the property price – taking you up to the £250,000 threshold £125,000 x 5% £6,250
£250,000 – £925,000 £100,000
(£350,000 – £250,000)
8% on the last £100,000 – up to £350,000 total property price £100,000 x 8% £8,000
TOTAL £16,800

In total, you’ll pay £16,800 in Stamp Duty for a £350,000 property.


Capital Gains tax

When you sell your property, a percentage of the profit you make (your ‘capital gain’) on the sale is taxed.

Your capital gain is calculated by deducting the price of the property when you bought it from the price you sell it at.

There’s a tax free allowance of £11,700 for 2018-19. For any gains above that, you’ll pay 20% if you’re a Basic Rate taxpayer and 28% if you’re a Higher Rate taxpayer. The taxable gains are added to your income when the HMRC works out your tax rate, so you might have to pay the Higher Rate even if you typically only pay income tax at the Basic Rate.

For example

You bought your property for £200,000 and sold it for £250,000. Your capital gains are £50,000. (£250,000 – £200,000 = £50,000).

First deduct the £11,700 allowance from your capital gains: £38,300 is taxable (£50,000 – £11,700 = £38,300).

Assume you have a yearly income of £41,850. This puts you in the Basic Rate tax band (because it’s below the £46,350 threshold for Basic Rate income tax). £30,000 of your income is taxable at 20% after deducting the £11,850 income tax personal allowance. So you will pay £6,000 in income tax (£30 000 x 20% = £6,000).

Add the £38,300 to your taxable income of £30,000: £68,300.
This pushes you into the Higher Rate tax band by £21,950 (£68,300 – £46,350 = £21,950).

You pay Basic Rate on the capital gains up to the £46,350 threshold. That’s 18% of £16,350: £2,943.

You then pay tax on the remainder of your taxable capital gains at the Higher Rate of £28%. That’s 28% of £21,950 (£38,300-£16,350): £6,146.

So you’ll pay a total of £9,089 in Capital Gains tax (£2,943 + £6,146 = £9089).

Any costs you incurred in purchasing the property and selling the property, such as Stamp Duty, agency fees and repaying your mortgage, aren’t deducted from the Capital Gains calculation. However, you can deduct the costs of any renovations you made to the property while you owned it.

Many landlords transfer buy-to-let properties to their children or other family members without actually selling it. This is still considered a capital gain for tax purposes, even if no money was paid for the property, and the original owner is liable to pay Capital Gains. The property is valued by a surveyor when you transfer it, and Capital Gains tax is applied to the increase in value. 

Risks

As with any investment, there are a few risks and uncertainties associated with buy to let properties – the forecasts for your rental yield and capital growth aren’t guaranteed. Here are some things you need to keep in mind.

Empty property

You might not have tenants for your property for some periods, and this cuts into your rental income.

If your property is empty, you’ll still need to keep up interest payments for your mortgage, and you may be liable to pay council tax and utility bills. This is a bigger risk with short term lets and areas with less rental demand.

Landlords should start looking for new tenants as soon as you know your current tenants want to move out.

It’s best to invest in a property that provides with a higher rental yield. This will keep your overall revenue high each year, which can offset the risk of empty property losses.

Unpaid rent

Your tenants may stop paying rent. You should ask for a deposit equal to a month’s rent at the start of the tenancy, and you can retain this to cover any unpaid rent. You can also evict your tenants by serving a Section 8 notice (the landlord has this right under Section 8 of the AST agreement).

However, you can only apply Section 8 if your tenants are in arrears by more than two months, and the process of eviction can take several more weeks. Your tenants’ deposit will only cover your rent losses for one month.

Resale Value

To make a profit when you sell your property, your resale price needs to be more than what you paid for it, and the upfront costs you incurred when you bought it.

Although property prices have been increasing in the UK over the last few years, there’s always a danger that house prices might fall after you buy your buy to let property. But as long as you can keep tenants in the property and maintain your rental income, you might be able to weather the storm by holding onto the property while house prices are low and sell when the property’s value is higher.

You can also boost the resale value of the property by renovating it to suit your target buyers and adding modern furnishings and appliances.

The right investment for you?

There are many different investment options to consider, and it’s important to think carefully about what’s right for you.

However, you don’t necessarily have to choose between buy-to-let properties and other investment options. If you can achieve a high rental income, you can reinvest this cash into and ISA, a pension scheme or other opportunities.

Your property itself can be a very valuable asset to leave your heirs. If you sell your property, the capital you make as a profit can help pay for a retirement home or new investment opportunities.