Investing in rental property is not for those looking to make a quick buck. These days, most rental owners see their investment as a project that can generate both income and capital gains, but over the long term. As with any investment, they can expect ups and downs, tough years and easier years. Last year was quite difficult.
Typical interest rates on rental mortgages began to slowly rise in early 2022, surged after Liz Truss’ unfortunate “mini-budget” in September, and remain volatile. As a result, the cost of new loans is higher than what homeowners had grown accustomed to over the many years of extremely low interest rates we had previously enjoyed.
On the other hand, the strong growth of property values in recent years and a deep structural imbalance between supply and demand in the private rental sector mean that the longer-term situation should remain positive for many rental investors. But every owner should run their buy-to-let business like a going concern. How can they best do this while facing a significant increase in interest payments?
There are different avenues landlords can explore: raise rents; repay debt; sell and exit the market – or convert/buy into a limited liability company.
Raising rents is perhaps the most obvious move, and one that many landlords have rolled out, judging by the data. According to Rightmove, national average rents outside London rose 9.7% last year to a record £1,172 per month at the end of 2022, Outer London rents hit a record high of £2,480 and central London rents hit £3,000 a month for the first time. But price elasticity can only expand until tenant affordability collapses, so landlords need alternative strategies.
In today’s economy, paying down debt may not be a viable choice. In fact, taking advantage of expanding a portfolio can still make sense given the huge demand for rental property in many parts of the UK. Indeed, a major survey we conducted in H2 2022 among Landlord Leaders found that 80% of professional landlords and 40% of part-time landlords had or planned to buy more properties, while 68% of all owners had or were planning to buy invest in upgrading their rental stock to make it more energy efficient before any changes to the energy performance certificate rules – hard proof that they are playing the long game. , selling might be the last thing any owner wants, given the potential for long-term success.
Which brings us to the purchase-lease in public limited company.
The steady reduction in tax breaks on self-owned rental investments has caused a flight to rental company heaven over the past five years, with the number of registered companies doubling to more than 300,000 between 2017 and October. 2022, according to Companies House data compiled by Hamptons. The rising cost of borrowing is likely to support if not exacerbate this trend towards incorporation, as the tax benefits can be very attractive.
In a limited liability company package, owners can still offset 100% of their interest payments against their tax bill – relief that is no longer available for personal purchases. Rental income is taxed at a corporate tax rate of 19% to 25%, rather than the owner’s personal tax rate, making incorporation particularly attractive for higher taxpayers (40% ) and the highest (45%). And LLC buy-to-lets are also more flexible in many ways, allowing owners to access the equity in their properties through administrator loans, for example.
But they can come at a cost – and it’s a tax advisor’s job to calculate whether that cost is worth paying for your clients, because each individual’s situation is different. As a broker, you should know the basics, but refer your clients to a qualified tax advisor for help.
Adrian Moloney is group director of intermediaries at OSB Group