In 1995, buy-to-let was a great investment. Over the last 20 years there’s probably been none better.
It wasn’t hard to find yields as high at 15% – even in London. And you got the never-ending inflation of house prices on top.
That’s changing. Here’s why.
No yield, no problem – house prices only go up
UK buy-to-let yields are no longer what they were, of course. They’re now closer to the 5% to 6% mark (gross) on average, and they’re lower in London. In Chelsea, they stand at 2%.
That’s because rents have not risen by anything like as much as house prices. Rents tend to stay in line with earnings, because most people use their earnings to pay their rent. House prices, on the other hand, are driven by what people can borrow. Borrowing is both easier and quicker than earning.
Yet this fall in yield hasn’t deterred the buy-to-let investor. He’s now relying on house prices going up – on capital appreciation. You buy a £100,000 house with a £20,000 deposit and an 80% loan. The house goes up by 20% and is now worth £120,000. As long as you’ve got enough to service the loan and pay any other running costs, you’ve doubled your money. Great. Such is the attraction of leverage.
And he’s been right. According to the FT, the “value of privately rented housing in Britain has grown 57% since the financial crisis, topping £1trn this year for the first time”. Buy-to-let landlords have seen the value of their portfolios grow by more than £200bn since the bailouts.
In recent years, buy-to-let has somehow escaped the tighter lending enforced on traditional mortgages. So the buy-to-let landlord, with more debt at his disposal, has outcompeted the first-time buyer, who now finds himself in renting instead of buying – hence ‘Generation Rent’.
However, as well as being a serious social problem, it’s a serious longer-term problem for a Conservative government – homeowners tend to vote Tory, tenants tend to vote Labour.
This is also a government that is (for all the noise about ‘the cuts’) running a deficit and really needs to raise more tax income.
And it seems there might be a plan to kill both of these birds with one stone.
The grand government plan to end buy-to-let
There’s a story doing the rounds online at the moment. I’ve been unable to prove if it’s true or not (if anyone can verify or discredit in the comments, I’d be grateful).
It tells of George Osborne visiting his local tax office in 2013, where staff showed him the tax return of a buy-to-let investor (with the investor’s name covered up). The investor had more than £150,000 in income, but had offset – quite legitimately – interest, wear and tear, repairs and professional fees, so that zero tax was payable.
Osborne was none too impressed, so the story goes. Hence the actions taken in his recent budget, where he altered various buy-to-let tax allowances. These changes have been covered extensively here, so we won’t dwell on them, except to say that they drive those landlords who are only just covering their costs a few notches closer to the margin.
So far, 9% of landlords plan to sell up, according to Barclays. Another 23% are thinking about it.
Osborne has since said he is considering further measures to curb the boom, including handing more power to the Bank of England to limit lending. The Bank itself said it was worried about buy-to-let back in the spring, and promised to ’monitor things’.
Tighter lending is now being clearly signposted. If the easy credit taps are switched off, that will cap house price inflation – which is the only thing that has been compensating for low yields.
Which leads me to the next part of the plan (assuming there is one).
Is Osborne hunting for the capital gains jackpot?
Osborne isn’t just targeting landlords for extra income tax. In 2012-13, the Treasury took in £3.9bn from capital gains tax (CGT) on property. The Office for Budget Responsibility (OBR) is projecting £9bn for 2018-19. That’s some rise, and not all of it can come through house price inflation. So how is the Treasury going to get that money?
Perhaps the answer is from buy-to-let landlords.
Most buy-to-let investors don’t sell. They see nowhere better to put their money. They don’t want to take an untapered 18% or 28% CGT hit. It’s usually better business to do nothing and keep collecting rent.
Osborne’s changes might change that attitude. They will make the day-to-day business of buy-to-let less profitable. Tighter lending would cap house price gains. Is this part of a plan to make the buy-to-let model less viable, so that – in true ‘ministry of nudges’ fashion – many choose to sell, allowing Osborne to claim his CGT?
A very British subprime
If that’s the plan, then there could be a problem. And my thanks go to the posters on a thread at website House Price Crash for alerting me to this.
Rather than sell to realise their gains, many buy-to-letters remortgage. They extract the capital and use it to buy more properties. Remortgaging now accounts for two thirds of all buy-to-let mortgage transactions, according to the latest Mortgages for Business Complex Buy to Let Index.
Of course, when a landlord remortgages, CGT is not payable. There has been no disposal in the eyes of the taxman. Even so, those who remortgage and use the money for something else – be it another property, or a treat – are extracting the gains.
How many of those people have put any of that money aside to pay future CGT? Not many, I suspect.
The maths of the situation are such that some will find that the CGT payable when they do sell will actually exceed the amount of equity they have in the house. It sounds impossible, but it isn’t.
Let’s say someone bought a £50,000 house in 2000 with a 90% loan-to-value (LTV – ie, a 10% deposit). Let’s say the house is now worth £211,000. So there is £161,000 of profit on which to pay CGT. After the annual allowance, he has to pay CGT on roughly £150,000 of gains, which is £42,000 (assuming the higher rate of 28%).
If the owner has remortgaged (to buy another property say, or simply to spend the money) so that his LTV remains 90%, he only has £20,000 of equity in the house. That’s not enough to cover the CGT bill. In fact, anything less than 80% and he’s in negative territory.
He can’t sell his other properties to cover the expense – the same problem arises there. The leveraged landlord is caught. So if he is already operating at the margin and relying solely on capital appreciation, and the recent changes to tax exemption push him into the red, there is a problem.
The irony is that the greater the capital appreciation, the more CGT is payable. Capital appreciation, previously what the whole game was about, becomes the problem.
If you get out your spreadsheets and start playing with the numbers, you realise how dangerous this situation potentially is. One accountant, who prefers to remain anonymous, has even put together a mathematical formula.
Not all buy-to-letters are heavily leveraged, but many are. According to the Landlord Centre’s Property Investor Profile, the current average LTV landlords are getting on buy-to-let mortgages is just under 75%. 75% own more than one property. At the extreme end, in Bradford and Glasgow, the average is eight.
After 20 years of bull market, buy-to-let is embedded in the psyche. It’s a peculiarly British investment. It will take some serious losses to change that attitude. And though the government is targeting it, it appears to realise the dangers and is taking a softly, softly approach.
But something has changed. A small snowball has started. If – and this remains a big if – the changes to tax exemption mean that many chose or are forced to sell, then CGT becomes an issue that could force the liquidation of portfolios. If there are large portfolios being liquidated in small areas, that affects local house prices. Then negative equity becomes an issue for the buy-to-let landlord.
We’re a way from that, but it would be a very British subprime.
• Dominic Frisby is the author of Life After The State and Bitcoin: the Future of Money.
Category: Market updates