Is buy-to-let a good investment?

If you’re interested in investing but prefer the idea of putting your money into bricks and mortar rather than stocks and shares, a buy-to-let property might be one option worth considering.

Putting your money into property – especially one you plan to let out rather than live in – comes with its own unique risks and challenges, which are vital to be aware of before you take the plunge.

In this article, we examine what’s involved in buying and owning a rental property and outline the pros and cons, so that you can decide whether it could be a worthwhile investment for you.

What is a buy-to-let property investment?

When you invest in a buy-to-let property, you simply buy a residential property, like a house or a flat, in order to rent it out to tenants. This means that you become a landlord, which comes with various responsibilities that we explore later.

As with many other types of investment, the hope is that your investment will provide you with a regular monthly income, which could be used to supplement your retirement income, or any other sources of income you might have.

There is also the prospect of capital growth – in other words, that your property will appreciate in value over the long term, so that you make a profit when you eventually come to sell it.

This might all sound fairly straightforward, but there are a whole host of variables to take into account when buying and letting property. If you’re not careful or just get unlucky, you could end up making a loss, just as you could with any other kind of investment.

What are the advantages of buy-to-let properties?

The main benefit of owning a buy-to-let property is that, provided you have limited “void periods” (those times when your property isn’t let out), you should have a regular income stream. Rental yields, particularly in northern areas, can be as high as 7% or 8%. Your property may increase in value over time too, although neither any income or any capital growth is guaranteed.

Many buy-to-let investors like owning property as it is a tangible asset, which gives them more control over it than a stock or share. Rather than buying interest in a stock and hoping it performs well, you have an active role to play in every part of the letting process. You choose the property and, as landlord, control how it is managed and oversee every aspect of the finances. This might be appealing if you trust your instincts and can be organised with both your time and money.

If you are an experienced investor then buying property can also be a good way to diversify your existing portfolio.

Can I take out a mortgage on a buy-to-let property?

The main cost of a buy-to-let property investment is of course buying the property itself. You could either use savings to buy the property outright if you can afford to, or you can fund your purchase using a buy-to-let mortgage.

Buy-to-let mortgages are fundamentally different to residential mortgages, and lenders will take a range of different factors into account when assessing your application, such as how much rental income the property is likely to generate. You’ll need to put down a bigger deposit too – whereas you can usually take out a residential mortgage with a deposit as small as 5% of the property value, most lenders require a minimum 25% deposit if you want to take out a buy-to-let mortgage. Buy-to-let mortgage rates and fees will usually be higher as well, as letting out a property is considered a riskier proposition for lenders than if you were simply living in it yourself. However, the good news is that current low interest rates mean that there are some competitive buy-to-let deals out there. You can compare costs using this buy-to-let mortgage comparison tool.

You’ll also most likely only be paying off the interest you owe the lender each month, rather than the capital, until the mortgage term finishes. At that point, you’ll either need to remortgage the property, or repay the capital (either by selling the property or using your own savings). For an in-depth look at how buy-to-let mortgages work, read our guide to Understanding buy-to-let mortgages.

What is leveraging?

Getting a mortgage in order to make an investment, such as a buy-to-let property, is known as “leveraging” (or sometimes “gearing”). Even if you are confident that you can afford a property with your current savings, it would be worth considering using leverage as an option.

For example, let’s say that you had enough saved up to buy a property worth £100,000. If the property increased in value by 10% every year, then five years later you could sell it for £150,000, giving you a total profit of £50,000 (these examples exclude fees, charges, tax, and rental income for the sake of simplicity).

However, if there was another property in the same area worth £300,000, then you might decide to take out a buy-to-let mortgage in order to afford this property instead. Assuming you invest £100,000 of your own money and take out a £200,000 mortgage, and this property rises in value at the same rate as the cheaper one, then after five years you could sell it for £450,000. This gives you a total profit of £350,000 from your initial investment, or £150,000 after paying off your mortgage. In this way, leveraging allows you to access investment opportunities that would normally be outside of your savings.

Alternatively, you could stick with the £100,000 property and take out a buy-to-let mortgage for £50,000. The benefits of leverage here would be twofold: firstly, it would allow you to invest your remaining £50,000 in other properties or ventures at the same time. Secondly, the overall return on your initial investment would be higher when expressed as a percentage: if you put in £50,000 and make £100,000, then this amounts to a 100% return, which is technically a more successful investment than putting in £100,000 and making £50,000 (a 50% return), even though after paying back the mortgage your profit will basically be the same amount. A higher percentage return is seen as more successful in the context of an investment portfolio.

Being able to invest in more expensive properties or multiple properties at the same time also generally means that your rental yield from these properties will be higher, which is another way that leveraging can result in greater earnings than you would normally achieve with your own savings.

The downside to leverage is that the same principles apply in reverse: just as the potential reward is higher, so is the potential risk. If the property goes down in value, you may not have enough to pay off your mortgage just from selling it, and might have to dip into rental income or your own savings in order to cover the rest. Your percentage return will suffer as well; if you bought a £300,000 property outright and its value falls by 20% to £240,000, then you will only have lost 20% of your investment. If you only put down a 50% deposit of £150,000, however, then the same £60,000 loss is equivalent to 40% of your investment.

What other costs are involved with buy-to-let properties?

If you’re considering purchasing a buy-to-let property, you’ll have to take into account all of the usual costs that come with buying property, beyond the price of the property itself. These include getting the property surveyed, fees for a conveyancing solicitor, mortgage arrangement fees, and the costs of buying furniture if you plan to let it out furnished.

If you live in England then you’ll have to pay the Stamp Duty Land Tax surcharge as well. This applies to second homes and buy-to-let properties and will cost an extra 3% on top of standard Stamp Duty rates..

If you live in Scotland then you’ll have to pay Land and Buildings Transaction Tax, which costs an extra 4% on top of the current rates for any additional property costing over £40,000.

If you live in Wales then you’ll pay Land Transaction Tax. This will cost an extra 3% on top of the current rates for any additional property costing over £40,000.

You can find out more about how Stamp Duty works in our article Stamp duty explained.

There are other unique costs you’ll have to keep in mind as well. If you plan to let or sell through an agency then they will charge you for their services.

Once you have successfully found tenants then you’ll still need to be prepared to pay for basic running and maintenance costs for the property as well.

How much tax do I have to pay on income from a buy-to-let property?

Any income you make from letting the property will be subject to income tax, if that income pushes you over your personal allowance. The personal allowance is the amount of income you can earn each tax year without having to pay tax, and for the 2021/22 tax year is £12,570.

However, you will be able to deduct most expenses from the payable amount, as long as you can prove they’ve been incurred solely for the purpose of renting and maintaining the property. These include insurance policies, the costs of general maintenance and repairs (but not improvements), services such as gardeners or cleaners, and various legal costs. You can find out more about income tax for landlords and how exactly these allowances work here on GOV.uk.

Landlords used to be able to deduct their mortgage interest before paying tax, which meant higher rate taxpayers could benefit from 40% tax relief on their mortgage payments. However, this has been gradually reduced over time,so that all landlords, regardless of whether they pay tax at the basic, higher or top rate, are given a flat-rate tax credit based on 20% of their mortgage interest.

Finally, when it comes time to sell the property, there may be Capital Gains Tax to pay if you make a profit that exceeds your annual Capital Gains Tax allowance. In the current 2021/22 tax year, this allowance is £12,300. If you’re a basic rate taxpayer and your income is £50,000 or less, you’ll pay Capital Gains Tax at a rate of 18%, rising to 28% if you’re a higher rate taxpayer with an income of £50,001 or more.

You can deduct certain costs from any gain, such as estate agent’s and solicitor’s fees, Stamp Duty when you bought the property and the cost of any improvements you’ve made, such as fitting a new bathroom.

Buy-to-let as a limited company

One growing trend for avoiding some of these strict taxation rules is to consider setting up your buy-to-let properties in a limited company structure. Owning property or properties and earning income from them as a company subjects you to different tax rules than if you own them as an individual. This is because a company is treated as a separate legal entity to its owner or owners.

The key difference is that companies do not pay Income Tax or Capital Gains tax. Rather, they pay Corporation Tax, which is currently set at 19% of all profits, regardless of the level of profits. This applies to both rental yields and money made from selling the property.

Bear in mind that only individuals, not companies, can claim the £12,300 Capital Gains Tax allowance. If you are dealing with one cheap property on a relatively short-term basis then it may be more cost-effective to own and sell the property as an individual, as the Capital Gains Tax paid after applying the allowance will likely be lower than the Corporation Tax paid at full price.

However, If you are dealing with multiple properties or one more expensive property, then letting as a limited company can greatly reduce the amount of tax paid on your earnings. The downside here is that the income will then belong to the company rather than the individual, and getting the money out of the company – either through dividends or in the form of salary – comes with its own tax consequences, which could end up offsetting the savings you’ve made. There can also be significant costs involved if you’re transferring a current buy-to-let property into a limited company as this can lead to Stamp Duty and Capital Gains Tax charges at the time of transfer. It’s essential to seek professional tax advice if you’re considering doing this.

Overall, buy-to-let property is subject to much greater taxation than other types of investments, which could be another reason to consider stocks and shares or traded property funds instead. Your returns from a buy-to-let property will have to be much higher than other kinds of investments at an equivalent level in order to cover tax.

Do I need insurance for a buy-to-let property?

There’s no legal requirement to have buildings insurance on your buy-to-let property, but lenders won’t offer you a mortgage unless you have this cover. Buildings insurance covers the cost of repairs to your property in the event of structural damage or replacing items such as pipes, drains and cables.

Many insurers offer specialist landlord insurance policies, which typically include both building insurance and contents insurance. If you’ve furnished the property yourself, having contents cover can provide valuable peace of mind that if any of your furniture is damaged, you can make a claim to replace it. A good policy will also cover costs specifically related to letting, such as malicious damage by tenants, legal and liability protection, and rent guarantee insurance (which means that you will be covered if a tenant fails to pay their rent).

What are the risks of investing in buy-to-let properties?

Even though buy-to-let properties can be a good investment, there are some potentially significant risks to consider if you’re thinking about becoming a landlord.

As the costs of buying property are so high, buy-to-let properties should be considered a long-term investment, which means your money will be tied up for a long time. It would be unwise to invest in a buy-to-let property if you don’t expect your finances to remain stable for the foreseeable future, as you might find it difficult to sell your property quickly.

Unlike stocks and shares, a buy-to-let property requires constant attention to maintain, and you’ll need to be prepared to sink a lot of time, effort and money into your property. Remember that it’s much easier to invest smaller amounts in stocks and shares than it is to invest them in property. Also unlike a stock or share, a buy-to-let property is “illiquid”, which means that it cannot easily be converted into cash. Buying and selling property is a complex, costly process within itself, much more so than selling “liquid” assets like stocks.

There are also certain factors that fall outside of your control that may result in an overall loss. If housing prices in the area fall then your property is likely to suffer as well; the amount of rent you can charge will decrease, and you may struggle to pay back your mortgage as a result. Even if you were to sell it there would be no guarantee that you would get back what you’ve spent on it. Market trends are tricky and unpredictable, so make sure you know what you’re getting into when buying a property, particularly one in an area you aren’t familiar with.

You could also get unlucky and not find any tenants to rent your property, or tenants who fail to pay their rent, which could make it hard or impossible to pay back your mortgage. Finally, your property could get damaged or fall victim to other unexpected issues and it would fall on you to pay for repairs, unless you have landlord insurance which will cover these costs.

If you are keen to expose yourself to the property market but find these risks off-putting, then you could consider investing in property funds. This means that your investment would still be liquid and fairly hands-off, and wouldn’t require the same financial and time commitment to maintain. Property funds still come with risks however, so you must be comfortable with the fact you could get back less than you put in.

Is it worth investing in a buy-to-let property?

While investing in a buy-to-let property can be profitable if you’re lucky, you’ll need to weigh up all the pros and cons carefully first.

If you’re not sure whether your finances are in the right place to start thinking about investing in a buy-to-let property, consider speaking to a financial advisor. Read our guide on How to find the right financial advisor for you if you are unsure how to go about this.

VouchedFor are currently offering Rest Less members a free Free Financial Health Check with a local well rated financial advisor. There’s no obligation but once you’ve had your check, the advisor will discuss the potential for an ongoing relationship if you think it might be useful to you.

Have you invested in a buy-to-let property? What kind of advice would you give to someone considering it? Let us know! You can join the money conversation on the Rest Less community or leave a comment below.

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