Bye Buy-To-Let?
Richard Teather - Sat 27 Oct, 2007
Darlings capital gains tax reforms have been heralded as good news for buy-to-let investors. Under the old system, unless you were selling a business asset (which buy-to-lets arent), taper relief would give you a tax rate between 40% and 26%, depending on how long youd owned it. But that is all to be swept away, and everyone will pay a flat 18%. Thats a big tax reduction, but is it really good news?
We recently commented on how Alistair Darling’s reforms could damage the AIM market. Now let’s look at a potential disaster lurking in the Budget for the housing market.
Darling’s capital gains tax reforms have been heralded as good news for buy-to-let investors. Under the old system, unless you were selling a “business asset” (which buy-to-lets aren’t), taper relief would give you a tax rate between 40% and 26%, depending on how long you’d owned it. But that is all to be swept away, and everyone will pay a flat 18%.
That’s a big tax reduction, but is it really good news? Thanks to the housing market bubble, most buy-to-let investors are getting tiny rental yields but sitting on large capital gains. With the market expected to flatten out – if not worse – the temptation is to sell and take the profit, but people are put off that by the thought of a huge capital gains tax bill. If that tax bill is halved from April 6th 2008, a lot of buy-to-let owners could see it as a good time to sell - flooding the market.
Let’s look at an example. Say you bought a typical London flat three years ago for £225,000, with an 80% interest-only mortgage. You are now getting a monthly rental of £1,350, but the initial discount on your mortgage is running out so your interest rate is about to go up to 7.59%. That leaves you with a profit of £212 per month, or just £1,526 per year after tax – before deducting any management or maintenance costs.
That flat is probably now worth £330,000. If you sold it, after the capital gains tax changes next April you should be left with over £132,000:
Forget what you paid for it; that’s history. Your real investment in that property is £132,756. On which you are making a profit of £1,526 per year. That’s a yield of 0.1%! The real situation is even worse; factor in a 12% management fee, £900 per year maintenance and 5 weeks per year void, and you are looking at an annual loss of 1.3%.
Even with a fairly optimistic house price increase (say 6%, less 18% tax), that leaves you with a net yield of 3.6%. Pathetic! You can get 4.1% guaranteed after tax from a savings bond with the Abbey! Compare it to unit trusts - gold funds up 50% in the last 12 months, India or Eastern Europe the same, and plenty of China funds returning over 100% on the year - and your buy-to-let is now grossly under-performing.
This doesn’t mean that you should necessarily sell. But lots of other investors will be doing the same sums, and many of them will conclude that buy-to-let isn’t worth the hassle for the next few years. There are about 800,000 houses owned on buy-to-let mortgages. About 450,000 houses come on to the market each quarter. Even if just 20% of buy-to-lets are put up for sale next April, that would flood the market. With confidence low anyway, that could easily cause a slump.
Regards,
For The Daily Reckoning
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