Private landlords facing much higher tax bills
The viability of the residential buy-to-let (BTL) business model has been called into question by Iwona Hovenko, equity research analyst of real estate, housing and construction at Bloomberg Intelligence.
Hovenko said the model is seeing some difficulties with private landlords facing much higher tax bills and other hurdles, including the need for costly energy-efficiency upgrades, triggered by legislation changes.
“This, combined with prohibitive transaction costs, resulting from hefty stamp duties, may curtail the UK’s BTL market,” she said.
She went on to explain that there has been an exodus of landlords from the sector - leaving with the intention to sell. Propertymark data showed an accelerated outflow from March 2019 to March 2022, as 84% of landlords that withdrew their property from the rental market in those three years did so to sell.
“This is likely a result of the tightening regulation that has drastically curbed returns. This has led to 49% fewer rental homes per realtor branch in March versus the same month in 2019,” Hovenko added.
She said that while the tougher BTL rules were meant to help first-time buyers by reducing competition from property investors, the legislation may have backfired, as limited rental stock drives steep rent rises, meaning prospective buyers may find it tougher to save for a deposit.
At the same time, Hovenko said the demand for rentals may increase, given the stretched housing affordability and mounting economic headwinds, which could deter some buyers.
According to Hovenko, the key changes in BTL tax legislation are the phaseout of the deduction of finance costs and the withdrawal of the automatic 10% wear-and-tear allowance.
“The shift may render the investment money-losing if the applicable marginal tax rate doubles to 40% from 20%, as almost all rental revenue is now taxable,” she said.
Higher-leveraged BTL portfolios may become unprofitable, especially as interest rates rise.
Private landlords with several leveraged properties, Hovenko said, could see the additional costs add up to a significant loss, triggering disposals, with proceeds potentially used to cut leverage.
Hovenko explained that the falling returns were also driving a ‘professionalisation’ of the BTL sector, with small, private landlords exiting the industry and others with larger portfolios now operating as a limited company, rather than a private individual.
In addition, she believes that a limited-company structure could lower tax bills applicable to BTL landlords, yet she said a massive shift of private landlords to a corporate vehicle is unlikely.
“That is due to the high cost of transferring privately owned BTL properties to a company, given mortgage-transfer costs and the property taxes applicable,” she said.
Diving deeper, Hovenko said that a private landlord would crystallize a capital-gains tax on the ‘sale,’ followed by the company having to pay stamp duty tax on the “purchase” of the property. That said, she detailed that about half of all 2021 residential-property purchases by investors were acquired via limited companies, based on data from Hamptons.
The stamp-duty hike on non-primary residences is a major barrier to new landlords entering the UK’s BTL market, and Hovenko believes it will deter some private investors and company buyers.
“On average, stamp-duty tax expenses in England and Wales for a higher-rate taxpaying landlord are more than one and a half years’ worth of after-tax rental income,” she added.
Following recent changes that have resulted in rising tax bills, Hovenko said potential landlords will have to wait much longer before making any profit on their property, especially in the most expensive regions.
“Ironically, that is where demand for rented housing is the highest due to constrained affordability,” she said.
Looking to other financial challenges facing landlords, Hovenko pointed towards the government’s push for all privately rented homes to achieve an EPC rating of ‘C’ in the coming years.
Read more: Check your property’s EPC rating, homeowners are told
Based on the 2019-20 English Housing Survey, upgrading a home with an EPC rating ‘E’ to band ‘C’ may cost £13,285, which Hovenko believes has likely risen further amid steep build-cost inflation.
“Renovation capacity may also not be sufficient to complete such a scale of works in such a short period,” she concluded.
