10 Reasons Property Falls Down for Investors
Despite relatively poor returns over recent years, property has never lost its siren-like attraction for investors; there just seems to be something comforting about bricks and mortar. On the other hand there are a lot of potential pitfalls to take into account:
- It’s probably overvalued
The house price to earnings ratio shows that houses are now more expensive that at any point in the last 30 years (other than immediately before the banking crisis).
An alternative measure compares mortgage payments as a percentage of take home pay. On this measure it’s not as pronounced: property costs are only slightly above 30 year average (however this probably simply reflects today’s low interest rates).
- Extra stamp duty
The government recently introduced an additional 3% stamp duty charge on all second property purchases – so buying a £150,000 buy-to-let property now costs an extra £4,500.
As well as dedicated property investors, this also catches the casual ‘additional landlords’ – the people who move house but decide to let out their old property. Buying a new home without selling the old one triggers the additional 3%, so, for example, retaining a £150,000 house as a but-to-let and upscaling to a new £300,000 family home would mean an extra £9,000 in tax.
- Gearing increases risk
The principle of borrowing to invest means that many property investors have made exceptional returns, but it must be remembered that it increases risk.
For example, if an investor borrows £100,000 to fund the purchase of a £150,000 property and the value then falls 20%, the equity in the property falls from £50,000 to £20,000 – actually a 60% loss to the investor
In a worst-case scenario you can end up in negative equity – that is, with the property being worth less than the outstanding mortgage.
A much overlooked factor is simply the hassle of owning a buy-to-let property. Dealing with tenants, letting agents and solicitors; maintaining the property and complying with the various lettings red tape mean that being a landlord comes with more hassle than many might want. Share portfolios certainly carry risks, but at least they never ring you in the middle of the night to complain that the boiler’s broken!
With conveyancing, stamp duty and then all of the ongoing maintenance and management costs, the costs of property are not inconsiderable and can easily take a big bite out of the investor’s returns.
- Capital Gains Tax (CGT)
Gains from property sales can be set against the £11,100 annual CGT allowance, but you can’t very well sell a bit of a house each year. Property investors often end up with a property ‘pregnant with gain’ and eventually use only one allowance (in the year of disposal), with the others being wasted.
Even worse, property sales are now subject to higher CGT rates: 18% or 28% (depending on your income) compares to the normal rate of 10% or 20%.
- Income Tax
Unlike stocks and shares, residential property can’t be sheltered in tax efficient vehicles such as ISAs or pensions, so there is little you can do to shelter the rental income.
Also, the rental income (less any Mortgage Income Tax Relief) is added to your income and taxed accordingly – which for some could mean a loss of Child Benefit by triggering the Higher Income Child Benefit Tax Charge.
- Mortgage Income Tax Relief
The finance cost relief on property investment borrowings is being reduced from full income tax relief to 20% over the next few years which will significantly increase the income tax bill for higher rate tax payers.
- Inheritance Tax
For those with property portfolios, Inheritance Tax is an increasing concern with potentially 40% of the value of the portfolio being payable to the tax man on your death. Unfortunately, compared with stocks and shares investments, there are fewer tax planning avenues available to property investments.
- Interest Rate risk
With interest rates at historic lows, and the impact of Brexit unknown, there is arguably a significant risk that interest rates could have to rise sharply in the coming years.
For landlords with mortgages this creates a direct risk that their mortgage costs will rise sharply, not only making it a poor investment but perhaps also jeopardizing their personal financial security. Landlords without mortgages are not completely immune either, as a spate of buy-to-let investors exiting the sector might well lead to property price falls.
Finally, you should remember that property investment, like all investment, carries investment risk and you could get back less than you have investment. And, as explained, with mortgage backed property investment you can actually lose more than you invest.
Please use Vouchedfor to find a local independent financial adviser (IFA) who can explain the pros and cons of property investment, and the alternatives available to you.