With interest rates being held once more last week, and likely to rise only slowly going forward, the debate about whether income investors should look towards buy-to-let to generate the income they need raises its head again.
Property certainly has its appeal, having historically delivered a good rental yield, along with providing an attractive level of capital growth over the long term. With demand for rented accommodation remaining high, due to low levels of house building and low wage growth, becoming a private landlord still looks an attractive proposition for many.
Property has also been seen as attractive in the past due to the leveraged effect on the investment. For example, you may put down a 10% deposit on a £250,000 house but you get growth on the whole £250,000.
However, a lot of would be private landlords focus on the potential yields offered but ignore the costs involved. These can quickly add up and eat into the returns, particularly since the recent tax changes.
To start with, you need to take into account the initial buying costs, including legal fees, agency fees and survey fees, all of which are usually paid up front. If you are buying with a buy-to-let mortgage, any initial costs and ongoing repayments must also be considered.
You will then need to find your tenants. Again, this will incur initial plus ongoing costs, if you use a letting agent to find and vet potential tenants and then manage the process for you.
Properties also have further ongoing costs, many of which will need to be paid even if the property becomes vacant for a period of time. These include redecoration and repairs, gas and electrical appliance maintenance, buildings and contents insurance, legal insurance plus the costs of complying with the various landlord regulations.
If you are looking for the best possible rental yield, it is also more than likely that you would need to buy in an area some way from where you live. This could cause you additional hassle and costs if something goes wrong.
Then there are the tax implications. An extra 3% stamp duty is payable on second properties and capital gains tax is payable at 28% rather than 20% for other assets for higher rate taxpayers.
In addition, rental income is taxable in accordance with your income tax banding. Changes between now and April 2020 to the rules regarding tax relief on finance costs (such as mortgage interest) could significantly increase the amount of tax payable by higher and additional rate taxpayers.
Property is also illiquid, which means it can be difficult to realise in the short term, whilst owning your current home and investing in buy-to-let properties could lead to a lack of diversification, with you too heavily exposed to the property market.
So property can be a good source of rental income and of course capital gains but buy-to-let comes with costs and can be quite time consuming.
An alternative option to generate income is to invest your monies in equity income funds or corporate bond funds. For many, the low fees, attractive yields and potential tax advantages of equity income funds make them a more suitable choice for most individuals than a buy-to-let property.
Equity income funds normally look to provide both income and long-term capital growth by owning shares in well-managed, dividend-paying companies. You can either withdraw and spend this income or you can reinvest it to achieve a higher rate of capital growth over the long-term.
You can also choose to hold the funds inside an ISA or a SIPP, making them extremely tax efficient. Bear in mind that tax rules can change and the benefits depend on personal circumstances.
Obviously, for those who do not need immediate income, pensions are also very attractive, with many tax advantages. You have tax relief at your highest rate on contributions and no CGT on gains. You can also take 25% of your fund tax-free, whilst the remaining fund is not subject to inheritance tax on death, whereas your properties will form part of your estate.
Property is tangible, and more understandable for many, hence its enduring appeal. However, the recent legislative changes make it less attractive than before as an investment for those relying on buy-to-let mortgages.
So if you are looking at the best way to generate income from your investments, both now and in the future, talk to Kellands.
All investments and income can fall as well as rise so you could get back less than you invest.