Greedy buy-to-let landlord or mortgage prisoner?
Being a greedy buy-to-let landlord, I was super excited earlier this year to hear about soaring rents in London, tens of viewings for each property, and would-be tenants engaged in bidding wars.
Music to my ears, because my London buy-to-let was coming to the end of a three-year tenancy.
I was going to cash in big time!
Let’s see how it worked out.
The property in question is an ex-local-authority three-bed freehold house in Tower Hamlets. The tenancy that was coming to an end was paying me £1,900 per month. (Down from £2,000 in 2019).
I’ve now re-let it for £2,400 a month for three years. Good, but given those headlines not as good as I thought it might be:
- It’s let to three migrant workers, who earn about £75,000 between them. (They are cleaners and waiting staff).
- The £28,800 they’re paying in rent is nearly 40% of their gross pay. I’d argue they are paying the maximum they can afford. (Wages should be higher, but that’s another story)
- It’s let and managed through an agent, who takes roughly 16% plus VAT plus a load of other sundry stuff. It totals a bit more than 20% of the rent.
- Other annual costs add up to a bit more than 10%. (My estimate, based on my long actual costs over the years).
- If we assume (optimistically, but it makes the maths easy) 30% all-in costs (excluding financing) then this property earns: £2,400*12*(100%-30%) = £20,160 net.
- Zoopla thinks the house is worth £700,000. That is wildly optimistic IMHO; it’s clear their machine-learning algorithm hasn’t seen the place. Let’s call it £600,000.
- The gross yield is £28,800 / £600,000 = 4.8%. That doesn’t seem so bad.
- Costs bring that down to £20,160 / £600,000 = 3.36% net (before financing)
Now if that was all there was to it, these figures might seem reasonable and fairly dull. You’d not be biting my hand off to buy this asset, would you? But nor is it an obvious sell.
You could even argue I’m getting a greater than 3% inflation-linked return. Not terrible by any means.
Mortgages and taxes
A few years ago a piece of stinging legislation – Section 24 of the 2015 Finance Act – changed the economics for greedy buy-to-let landlords like me.
In the post-Section 24 era, you have to pay tax on the rent (after all non financing costs) at your marginal rate.
You then you get a (lower) tax rebate for 20% of your financing costs. Which was a clever ruse. Because for many people, it pushes them into a higher tax band. Very often the 60% bracket between £100,000 and £125,000.
For this property I have a £300,000 (so 50% loan-to-value) fixed rate mortgage. The rate is around 2%. (This fix will last about four more years. Phew!)
The mortgage costs me 2%*£300,000 = £6,000 a year.
Let’s add all this up together:
I’ve also included the sums for a pre-Section 24 universe in the three rows at the end of this table as a comparison.
A few things stand out here:
- The 60% tax rate is beyond ridiculous. It’s random and illogical.
- Section 24 is also pretty ridiculous. (And no, I don’t care that regular homeowners can’t offset their mortgage interest against tax – touted as making Section 24 ‘fair’. Homeowners don’t have to pay income tax on their imputed rent either, do they?)
- After tax, our greedy buy-to-let landlord is getting anything between £11,000 and £3,000, depending on their tax bracket.
- Which one applies to me? The second from the right.
Earning 54bps on £600,000 is certainly nothing to write home about. But arguably what matters for our yield calculation is not the capital value of the property, but rather the ‘equity’ we have in it.
That is, how much ‘cash’ would we have if we sold it and paid off the mortgage?
On the face of it this appears to be:
£600,000 – £300,000 = £300,000 equity.
As you can see above, using the equity figure obviously makes the returns look a little better. Still I’d not exactly be thumping the table to get into this position.
Wait: it gets worse
All this maths is at the existing rate on my mortgage. But what if my fix was expiring today and I had to remortgage?
The lowest rate I could get is 5.3% (plus £2,000 in fees). I’ll explain how I can be so certain of this in a minute.
First let’s run the stress test:
Ugh, pass the sick bag.
A thought experiment. In this stress test scenario, how much would I have to increase the rent to break even on a post-tax cash flow basis, assuming I am a 60% taxpayer?
Well, because I only keep 40% of any increase, quite a lot. In fact it would require about a 50% increase to £3,600 per month. (Certain costs are somewhat fixed, others are not. That makes the estimate fuzzy).
Since my rival 20% taxpayers and corporate landlords would still be breaking even without such a hike, obviously I couldn’t do that. Plus it would equate to 58% of the tenants’ gross income.
Section 24 to me seems like just an excuse to charge higher earners yet more income tax.
But surely I could get a cheaper mortgage?
This is where the real fun begins. No, actually, I couldn’t.
This house is in Tower Hamlets. This London borough has an Additional Licensing Scheme under which it essentially deems all houses that are rented and occupied by tenants that do not form a ‘family unit’ to be Houses in Multiple Occupation (HMOs).
A conventional HMO usually involves: rooms let individually, short tenancies, the landlord being responsible for ‘shared’ areas, and so forth.
My house is not that. It’s just a regular house that’s let jointly to three sharers under one normal assured shorthold tenancy agreement.
However Tower Hamlets arbitrarily designating it as an HMO has also sorts of repercussions:
- I have to pay Tower Hamlets £569 every five years
- I have to comply with sundry additional health-and-safety regulations. Most of which are completely sensible best practice anyway, like having a mains fire alarm and so forth.
- Randomly we’ll have an inspection. Whereby:
- I’m responsible for the tidiness of ‘communal’ areas. Never mind that I’m also obligated to not interfere with my tenants’ peaceful enjoyment of the property.
- The tenants might have to swap all the furniture between the bedroom and the sitting room. Why? Because the bedroom is ‘too small’ according to the HMO rules. Never mind that there’s a large kitchen and enormous sitting room. And that it was Tower Hamlets that built this property in the first place. The compromise agreed to enable me to have three tenants is that they use the sitting room as a bedroom and the bedroom as a sitting room. And I’m sure this is what they do.
- I can’t change the mortgage provider. HMO mortgages are much more expensive, but my existing lender has agreed to ‘grandfather’ me, because it recognizes that it’s not really an HMO. But regular lenders now won’t touch it.
- My insurance is more expensive for the same reason.
- Presumably the open-market value of the property is reduced. Because, given its circumstances, the only likely purchaser is another landlord who would face all these issues as well.
Note that, if, for example, I let to two siblings and a friend, and one of the siblings started a sexual relationship with the friend, then they’d be a family unit and I wouldn’t have to bother with all this. Even though nothing of any relevance has changed about the people or the building…
Ironically the situation has encouraged me to run the numbers on turning it into an ‘actual’ HMO. If I’ve got to adhere to all this stuff anyway, why not get a higher rental income?
(Is this really the incentive the council intended, I wonder?)
In any properly functioning country, we wouldn’t need these silly rules. People would simply move out of crap housing and live somewhere else.
We’d need empty houses for them to move into, of course. That would require we build more houses.
But it’s much easier to blame greedy landlords and too-many Johnny Foreigners than to actually let people build houses.
Looking at that graphic, I wonder what the problem could be?
Won’t capital growth make up for it?
Will I make a killing if I sell my flat in years to come for megabucks?
Who knows. But my guess would be no. The easy money in London property was made long ago.
I’ve always let this property to immigrants (despite the government’s best efforts to make doing so more difficult) and the mood music there isn’t great.
Besides, I wouldn’t want to be running cash-flow negative in the hope of ‘making up for it’ with capital gains. Especially when such gains may yet be subject to ‘windfall’ taxes or whatever else politicians fancy inflicting.
Why not give up on the greedy buy-to-let landlord game?
I could just sell the property, of course.
If I then took my £300,000 equity and put it in my ISA (over a few years) I would have no trouble earning, say 4% p.a. in risk assets. (Which is what property is too, incidentally).
That would earn me £12,000 a year in income.
I could put the money into a FTSE 100 tracker. This would pay a 4% long-term inflation linked yield. It would cost 7 bps in fees. (iShares ticker ISF.L).
That fee is 1.7% of the ETF income, as my buy-to-let letting agent might like to note. Also a FTSE tracker will never call me to complain about leaky taps.
However on top of it not being a great time to sell property:
- I don’t really have £300,000 of equity.
- I can’t be bothered.
- There isn’t anything I want to do with the money. (I can afford to fill our ISAs already.)
Why don’t I really have £300,000 in equity?
Let’s run the numbers. If I sold it, I’d have to pay off the mortgage and pay capital gains tax (CGT):
Anyone who’s still paying attention is going to immediately say: “Hold-on-a-minute, if you bought it for £100,000, why have you got a £300,000 mortgage on it?”
Yeah, you got me. Back in the heady noughties I increased the mortgage to release cash to use as a deposit on other BTL properties. I’ve long since sold them all.
In a sense I’ve already had my cake and eaten it on this one. I’ve essentially extracted all the profit.
So on the one hand, I’ve ‘made’ half-a-million quid in capital gains. Not to be sneezed at. But at the same time it wouldn’t take that steep a fall in house prices (about 20%) before I was in negative equity (after capital gains tax).
For the record, in reality I wouldn’t have to pay quite so much CGT. Holding growth stocks outside of tax shelters and dabbling in crypto means I have losses available to offset the gain.
Also, I can’t be bothered
Just the added tax complexity of selling induces anxiety. I completed on the last property I sold shortly after the government introduced new rules that required the CGT on UK property to be filed and paid within 30 days of the sale. (It’s now 60 days).
Again, this system appears to exist out of spite rather than for any real reason. Something that becomes clear if you have any interaction with it:
- It’s separate from the annual self-assessment process.
- You have to file an on-line, one-off, intra-tax-year process, where you can elect to offset carried forward losses and the CGT allowance and so on.
- You pay any tax due (in my case tens of thousands of pounds).
- I had to do all this myself, because my accountant isn’t capable of doing anything within 30 days.
- After the end of the tax year you file your self-assessment. In my case I’d realised other losses, so my CGT bill should be zero.
- Naturally it’ll all come out in the wash of self-assessment, like offsetting your payments on account or whatever, right? Wrong.
- The special ‘UK Property’ gains tax system is not ‘connected’ to the self-assessment system in HMRC. Guess who’s responsible for sorting the mess out?
- Rather than net out the difference and send me a refund, I have to go and amend the original UK Property CGT filing and my self-assessment to ‘move’ some of the losses from the self assessment to the UK Property filing.
- To be clear, HMRC didn’t tell me this. My accountant did. And I can see no way you’d know that this is what you needed to do otherwise.
- I amend the original UK Property filing. Pretty much every page warns me that because I’m amending it after the 30 days deadline I’m likely to have to pay fines and penalties. Possibly jail time.
- I amend the self-assessment as well.
- Wait for the refund, right?
- Of course not. HMRC writes to tell me that I’m owed a refund. But it doesn’t have any way of paying the refund. Could I please phone them?
- Phone the number on the letter where, with dull inevitably, they know nothing about it. Spend the best part of a day going round different HMRC departments.
- Finally I get to the right person.
- HMRC will pay me my refund within 90 days. Yes, you read that right. I have to pay the tax within 30 days, but it gets 90 days to pay me the refund. (This is over a year since I paid the tax).
Now tell me that isn’t anything other than vindictive?
I suppose that in the politics-of-envy country we’ve become, anything that inconveniences greedy buy-to-let landlords is fair play, right?
There’s absolutely no motivation to sort it out. It doesn’t cost HMRC anything. And what am I going to do, pay my taxes elsewhere?
Chance would be a fine thing.
What’s the plan?
The plan is to bury my head in the sand and hope that something turns up in the three to four year window that I’ve bought myself.
The mortgage is fixed for four more years, and I’ve just agreed to a new three-year tenancy. A lot can change in three years. Interest rates might fall, rents might rise, my tax circumstances might change, Tower Hamlets might drop its stupid HMO rules, Section 24 might be repealed. (Okay, I was joking about the last two).
In the meantime I carry the (net-of-mortgage and tax) value of the property on my personal balance sheet as ‘a doughnut’ and ignore the income.
But maybe it’s not a complete waste of time and effort, after all. Because where are the migrants I just let the place to from?
That’s something positive, anyway.