- Patrick Maflin
It seems that a metric of one’s success in yachting is the number of properties you own, but is our desire to invest in this product simply due to image and its tangible nature? Bricks and mortar always look nice on paper, and most crew in this industry are income-rich yet asset-poor. However does this asset class still provide the best return on the capital invested?
‘George Osborne’s recent budget changes have certainly shaken the Buy To Let market, giving rise to landlords switching their portfolios over to ‘Limited’ companies in an effort to stem some of the losses from the changes in mortgage tax relief. While private landlords can currently claim tax relief on monthly interest payments at up to the 45% top level of tax, from April 2017 this will start to be reduced to 20%. Landlords will be able to obtain relief as follows:
- 2017/18 the deduction from property income (as is currently allowed) will be restricted to 75% of finance costs, with the remaining 25% being available as a basic rate reduction.
- 2018/19, 50% finance costs deduction and 50% given as a basic rate reduction.
- 2019/20, 25% finance costs deduction and 75% given as a basic rate reduction.
- 2020/21 all financing costs incurred by a landlord will be given as a basic rate reduction.
In the wake of these tax changes, there is still an argument in favor of investing in Buy To Let properties. The National Landlords Association (NLA) believes that these changes will see less properties available to rent, as the government still has not addressed the first-time-buyer crisis we are currently experiencing. If you consider this in supply-and-demand terms, a shortage of rental properties will cause rents to increase, thus easing the tax burden for landlords. If landlords were then to switch their properties over to ‘limited companies, they would be able to benefit from the forthcoming reduction of corporation tax to 18 per cent.
There is no doubt that individuals who invest in property do not always fully appraise the investment before going ahead, and it is important before you commit to purchasing a property that you sit down and calculate the rate of return. Below is an example of how to calculate the return on your investment:
For a £100,000 property that you could rent for £450 pcm, you would need a £25k deposit and roughly £2,000 in buying costs.
- £75k mortgage at 5% interest rate = £312.50
- £312.50 x 12 = £3,750
- £420 rental income x 12 = £5,040
- Difference = £1,290
- Deposit & Buying Costs = £27k
- Annual Return = 5.16%
Individuals tend to opt for property over other investments as it is the only true tangible asset. Property has, until recently, offered excellent capital growth, although signs would suggest that this is flattening. Tim Reedman from Reedman Wealth Management believes “you should appraise a Buy To Let investment in terms of whether you will ever live in the property, due to the tax paid on Buy To Lets”, as if you do not live in the property after 18 months, you will be subject to Capital Gains Tax (CGT), which starts at 18% per cent.
What alternatives are there on the market? It would appear that more and more crew nowadays are starting to look at managed investment portfolios, where you have an asset mix including equities, income fund bonds, cash and commercial property. However, with the volatility that we have all born witness to since 2008, the majority still seem to have concerns about placing their hard-earned money in something that is not tangible. Property also suffered from the effects of the crash, although many overlook this; the UK has seen tightening of mortgage lending with fewer applications approved, while high unemployment and repossessions have given rise to negative equity in some areas of the UK.
ISAs provide investors with an true tax-free wrapper around their investment, something few other options do. Tim Reedman believes, “If you purely appraise ISAs versus Buy To Let investments on a cost basis, ISAs win hands down”. The example below highlights the savings that can be made by investing in this way:
If Robert were to invest the maximum amount into Stocks and Shares ISA, straddling tax years, for a five year period, with an average investment return of 5 per cent, then the fund would have an approximate value of £100,000 which would be tax free.
This demonstrates the tax efficiency of investing in ISAs as opposed to Buy To Lets.
The problem with ISAs is that, to some degree, it is a leap of faith, as you do not know from the outset how the fund will perform. When choosing to invest your money this way, you must go for a top-down approach; asset allocation is key to getting your investment right. You must ensure that you have many eggs in many different baskets, from percentage shares through to equity funds.
Diversification is very important when considering investments. Buy To Lets are only one asset class in one geographical region, whereas an investment portfolio can contain multiple asset classes spanning many geographical regions, with proven fund managers in each respective area. ISAs can also be liquidated within 14 days and, in most cases, are not subject to redemption penalties.
It is essential that you read the small print when choosing such investments. In many environments outside the UK, the practice of initial units (upfront commission) whereby an investor pays the commission upfront is still in use. Initial units have seen many investors who have decided to cash out early make no gains at all, as they have not completed paying off the commission when signing up for the investment scheme. However ,this practice has been outlawed in UK-based financial planning circles for many years, as it was deemed very poor value for investors.
Buy to Let investments, when evaluated against ISAs, do not offer the same degree of tax efficiency, liquidity or diversification. They do offer a quantifiable rate of return from the outset, but this is not guaranteed income. It would appear, as Tim Reedman states that you need to have a balanced portfolio with mixed asset classes in different geographical locations. This seems to be the key to financial success.