Is the buy-to-let landlord a saver or an investor? This is a question I have asked myself many times and still not come up with a definitive answer.
In one respect, the landlord is very much a saver by putting money into an asset class that is, for the most part, recognised for stability and security. Unless confronted with a major structural fault or a neighbourhood suddenly and rapidly goes downhill, the landlord will normally find residential property as safe as… well… houses.
Returns will still be superior to current savings rates
On the other hand, the landlord is also motivated by a desire for a return greater than can normally be achieved from conventional savings. Before the financial crash, ten years ago, a savings account might return 5 per cent whereas a landlord could perhaps achieve twice as much when capital growth was added to rental income. Nowadays anyone will be extremely lucky to get 5 per cent from residential property but the return will still be superior to current savings rates.
The landlord is unlikely to experience the double-digit surges in value that sometimes come with share ownership nor is he particularly interested in devoting the time necessary to “play” the market and take advantage of rises and falls in prices. Nevertheless, by entering the world of residential rentals he is showing a willingness to take on a measure of responsibility and risk that does not come with a bank or building society passbook. Therefore as the landlord is neither wholly a saver nor wholly an investor, perhaps “savestor” would be the most appropriate term.
This hybridity is obviously part of the attraction of residential property as an asset class, yet it does come with expenses which, especially those considering entering the market for the first time, increasingly need to be aware of.
Going back to the good old days before the financial crash, the savestor might have felt confident enough to put aside just a small amount of gross rental income for wear and tear, especially as this qualified for 10 per cent tax relief without HMRC requiring production of documents as proof. However the allowance no longer applies, having been abolished at the end of the 2015/16 financial year.
For this reason, “wear and tear” needs to be taken more seriously as a cost issue than in the past. An HMO property with, say, six paying occupants (two couples and two singles) might produce an enviable level of rental income but the adverse effect on décor, furnishings and fittings will also be substantial, not necessarily as a result of excessive behaviour but by the tenants simply going about their daily lives. Failure to redecorate and renew time-expired items will – given today’s choosy tenants – result in longer periods of rental void. My advice would be to anticipate such expenses and include them within a general “sinking fund” to also cover the cost of repairs and the various compulsory safety inspections.
New tax regulations are also hitting net income. On 6 April last, tax relief on buy-to-let mortgages was reduced from 100 per cent to 75 per cent with total elimination due by 2021 when it will be replaced by 20 per cent tax relief on finance costs for all borrowers. Clearly higher-rate taxpayers will be most adversely affected but all private (as opposed to company) landlords with borrowings will suffer.
In summary, anyone looking realistically at the new environment in which the market operates should be prepared to set aside as much as 50 per cent of gross annual income from rent to allow for taxation and expenses. This may seem excessive but surely it is preferable to unrealistic financial projections coming home to roost at some later stage.
And the fact remains that with capital growth factored in, most overall returns from residential lettings will easily beat the historically-low rate of interest offered by a bank or building society. There is still much to be said for being a savestor.
• David Alexander is managing director of DJ Alexander