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I am active in a couple of property forums and try to give back a little into the wider property community when I can. Here is the essence of a recent forum exchange that I decided to wade in on to offer some thoughts to help the poster, who was probably feeling a little like after the lord mayor’s parade when he asked: Has the property ship sailed? Let’s find out if we can make a fist of BTL investing still, or if we need to now be looking at more complex and riskier strategies to make money in property.
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Today’s must do’s
If you are interested in BTL property investing, then I would suggest doing these three things: 1) don’t blindly aim for ‘set and forget’ capital growth; 2) do look more at a mix of capital growth and income returns and in doing so be more choosy on the location and properties you take on, and; 3) do understand that how you set up and structure your affairs these days is perhaps more important than it used to be: so get professional advice if you intend to have more than the odd BTL investment.
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Transcription of the show
Hello and welcome to another episode of The Property Voice podcast. My name is Richard Brown and it’s a pleasure to have you join me on the show again today.
Today’s show takes as its inspiration an exchange I had on a property forum in answer to the original poster’s question: has the property ship sailed?
Let’s dive right in now and respond to that question, which is probably on a lot of people’s lips at present anyway.
I am active in a couple of property forums and try to give back a little into the wider property community. Here is the essence of a recent post that I decided to wade in on to offer some thoughts to help the poster, who was probably feeling a little like after the lord mayor’s parade when he asked:
Has the property ship sailed?
He elaborated as follows:
I'm new to property and interested in growing a property portfolio.
I'd be really interested to know what people think about the reality of getting into property right now.
With a rising property market and all the changes in taxes, is it a lot tougher to make a success of property without going into more and more complex and risky property strategies?
Before I share the essence of my response, let’s start off with a few pieces of data.
In September 2007 – the average house price was £190,032
In April 2017 – the average house price £217,502
That’s a modest 14% increase over the ten years from the previous market peak, which includes a very significant bust period of 2007 to 2010/11.
In January 2005 – the average house price £150,633
In April 2017 – average house price £217,502
That’s a 44% increase over 12 years or a compound annual growth rate (CAGR) of 3.1%
There is a statistic that gets thrown around a fair bit in property that house prices double every 10 years or thereabouts. This appears to be true over a long-time period, however, we can see that over the past 12 years this has not really be the case.
Doubling house prices every 10 years does imply an annual house price inflation rate of an eye-watering 7% per annum. However, I am not sure that we should be relying on this level of above-inflation growth necessarily being repeated. That said, who knows for sure?
Let’s also take a quick look at different types of housing tenure.
In 1986, social housing, which comprises council housing & housing association provided homes, accounted for 29% of all housing tenures. But by 2014 this had fallen to 17%. Over this same period, privately rented housing has risen from less than 8% to over 16%. Similarly, and again over this same period, mortgage or rent-free housing has risen from 24% to 35%.
What does this data tell us?
Apart from the obvious fact that there is something of a generational divide, with many homeowners now starting to pay off their mortgages and live mortgage or rent-free, it s the mix of rented tenures that catches my eye.
It’s not necessarily about BTL landlords becoming a greedy that many people might like to focus on, it is that the private rented sector has had to fill a void left by a drop in social housing in particular. In other words, people will always need rented homes to live in, it’s just who provides them that has changed. I don’t see a massive reversal to this mix of rented housing providers any time soon, especially with the lack of new house building failing to meet our population needs contributing to a growing annual deficit each and every year.
Home ownership rates
Home ownership rates were around 64% in 1986 and whilst they peaked at around 73% in 2008, it seems clear in retrospect that this peak was based on an unsustainable level of easy-credit based mortgage lending. This level was probably unsustainable and whilst home ownership rates are probably going to increase once again, we need to put this into context. We still don’t have enough homes of every tenures and so we quite simply need more homes of ALL tenures, not just for home owners but for renters too. In short, the rental demand will continue, even with the effects of Brexit.
In terms of rents, there is less historic data available but it does appear that rents over the past 15 years have broadly tracked RPI inflation, or wage inflation.
Now let’s putting this all together, there is a very strong demand for housing of all tenures and we are not building enough new homes. Historic house prices do look as though they have been operating at hard to sustain levels, but just as the arrival of low interest rates has propped uo affordability levels, in a similar way to dual-income families in the past, I expect further changes to help support house prices in the future too. For example, lifetime or inter-generational mortgages to name but one.
If nothing else, I would expect a more moderate rate of house price growth rather than a dramatic and long-term seismic correction.
Rents should continue to track household expenditure levels and so should see increased returns also.
So, my conclusion is that no, the property ship has not sailed...but it is sailing through some choppier waters!
To elaborate, there are two key aspects of making money through property:
- Annual Income - via net rental income after all costs and tax
- Capital Growth - via realising an increase in the property value again after tax...with the key word being realising.
Historically, total pre-tax returns from BTL have been around 10% to 12% including both income returns and capital gains, with an approximate 50/50 split.
What has changed recently is taxation, which has taken a bite of the after tax returns. If we assume that the future returns will largely mirror the historic returns, which is a big assumption but a fair one to make, then all that would really change is the after-tax position.
The two big tax changes are the Stamp Duty Land Tax (SDLT) 3% premium for investment properties, which increases our costs going into the deal and also therefor affects our ROI. Then, there is the Finance Bill Clause 24 mortgage interest tax relief caps and a change into an allowance, which could reduce our after-tax income returns.
Put simply, we can't avoid the SDLT premium, so that's going to reduce our returns when compared to the past...although some landlords are looking to try and recover this extra cost by increasing rents. If we assume you can't pass on the cost as higher rent then clearly this impacts net income returns for the average investor...but it won't shift the net income ROI from approximately 6% to 3%...it will increase our entry costs only and so 6% ROI might turn into say 5.8% (6 / 100 vs. 6 / 103 is the maths behind that). So, not much different really.
As for Clause 24 - this will affect higher-rate tax payers by a fair bit, or push some basic-rate taxpayers into a higher tax bracket...and so will affect these a fair bit too. I won't illustrate the maths but this could take a bigger bite out of the income returns than SDLT. However, there are some potential ways around this including investing via a company, invest in higher yielding properties or locations, re-arrange our affairs such that we will be less impacted by these changes (seek professional advice to do this!) or change strategy (e.g. property trading) or investment location (region or even country). Here is the podcast I recorded on location in the USA that discusses higher yield investing there for example.
Finally, capital growth - if all we do is sit and wait, then we should hopefully achieve some capital growth over time (it does depend on location though). But we can't spend equity unless we release it in some way...so it's actually of no use to us until and unless we can release this capital growth by either selling or refinancing (careful with over-refinancing but that's another topic). Capital gains tax is pretty much the same as it used to be, although is now less favourable when compared to other capital assets...so compared to property returns previously, no change, but compared to say capital growth on stocks and shares, it's now less attractive.
Property does still have the advantage of allowing us to use leverage to grow our returns, which for the everyday investor, is not the case with say stocks and shares. We do get some tax breaks by investing through ISAs and pensions, so if we are looking long-term then we should also consider these at least as a part of our overall investment portfolio mix (I certainly do!).
I guess, we may see some softening to capital gains if house prices fail to match what they have done in the past. On the income side, despite some attempts to take a bigger bite out of our profits in the form of taxation, net rental income can probably hold up well under the right property conditions, including higher yielding locations and / or rental types and with good organisation of our ownership and tax affairs.
So, in conclusion...don't sell your ticket to the good ship BTL property just yet, but do undertake a little more research on which is the best cabin to book on the ship is what I would say!
There are still some decent opportunities without having to go too far down the complex or riskier property strategies route.
Ok, so that’s me for this week. Remember that you can email me firstname.lastname@example.org if you want to talk about anything from today’s show or more generally in property investing, the show notes will be over at the website www.thepropertyvoice.net
But for now, all I want to say is thank you very much for listening once again this week and until next time on The Property Voice Podcast…it’s ciao-ciao.