Contents
What is residential property investment?
Buy-to-let (BTL or B2L) is the most common residential property investment strategy – purchasing a property and letting it to tenants in exchange for rent. The goal is to receive cash rental payments in the short term, but also achieve capital growth in the long term as property prices increase.
Residential property investors may also use other strategies such as:
- Flips – A complete renovation of a property, with the aim to sell the finished property at a profit.
- Rent to Rent – Taking on the lease of an entire property and subletting to other tenants for a profit.
- BRRR – Buy, Refurbish, Refinance, Rent. Similar to a Flip but the investor retains ownership, and rents to tenants as a buy-to-let.
Often these strategies are combined and investors may choose to use different strategies depending on their local market or expertise.
First time buyers beware
If you are a first time buyer, be aware that a BTL is especially unlikely to be the best way for you to build wealth. The system of incentives and assistance for first time buyers is geared towards helping you buy your own home, not to start a rental business.
- As a first time buyer you can use the LISA scheme to get a £1,000 bonus each year of saving for your deposit. This can be used only towards your first home, not a BTL (nor can you use it for a home after buying a BTL).
- First time buyers in England and Scotland receive a one-off stamp duty relief to buy their first home, which cannot be used for a BTL. Additionally, stamp duty is charged at a higher rate on second properties.
- As an illustration, to buy a £400,000 home as a first time buyer in England, you would pay £0 stamp duty. If you bought a BTL first then sold it to buy your home, you would pay £7,500. If you kept the BTL, you would pay £19,500 in stamp duty. Your BTL would have to be extremely profitable to overcome these extra costs. For a quick comparison see this stamp duty calculator.
- Many mortgage lenders will not offer BTL mortgages to first time buyers at all, or will have higher deposit requirements for first time buyers. Your choice of lenders will be limited and you may not be able to access the best rates.
If you’re considering BTL before your first home, you will need to carefully calculate whether your expected BTL profits (after income tax, fees, maintenance costs and all the other factors described later on this page) are genuinely likely to surpass the first time buyer advantages you’re giving up, as well as what you could make from savings and investments.
How does Buy-to-let work?
A buy-to-let investor will purchase or re-mortgage an existing property with the intention to let the property to a tenant. When the rent received from the tenant is higher than the mortgage cost, and other ongoing costs, the investor makes a profit.
Additionally, house prices have historically trended upwards. The difference between the price paid for the property, less the outstanding mortgage, and the current price of the property is where investors can also make money through capital growth.
Buy-to-let investment in the short-term is about generating a cash flow, and in the long-term seeks capital growth from increasing property prices.
Active or Passive Investment
In a buy-to-let investment, there are things you must manage before, during and after letting the property to a tenant. Even with a good letting agent, you will need to manage re-mortgages, insurances, and bills during void periods (unoccupied property), organise and review quotes for repairs, submit tax returns, ensure your legal responsibilities are being met, and communicate with tenants or the agent.
Sound like a lot of work? It is. Buy-to-let is not a passive investment.
Although letting agents, accountants, and insurance and mortgage brokers can help you, these all come with a cost – which will eat into your profits. If you are seeking to become a buy-to-let investor you will have work to do and you should consider the time and opportunity cost when making an investment into a buy-to-let.
Buy-to-let Mortgages
In comparison to residential mortgages, which are commonly repayment mortgages, buy-to-let mortgages are usually offered on an interest-only basis.
The reason for this is that interest-only mortgages have less expensive monthly payments, so cashflows are improved. However, at the end of the term, the lender will still need to be paid back the initial borrowing amount.
During the late 1970s and early 1990s, there were periods of soaring interest rates (up to 17%!) which put serious pressure on those with variable-rate mortgages. However, during the 2010s and early 2020s, we saw historically low-interest rates meaning borrowing was cheap. At the moment we are operating in a raising interest-rate environment, which means borrowing is becoming more expensive.
As buy-to-let investors hope to achieve capital growth, the expected value of the property should be higher than the initial borrowed amount but there is no guarantee! You should have a plan in place to refinance or repay the loan before the end of the term.
There are some restrictions on buy-to-let mortgages such as the rental coverage, the loan to value and, for properties in personal names, you usually must own another residential property.
Rental coverage ranges between 125% and 150% of the mortgage interest amount compared to the rent received. It is tested at a stressed interest rate, which can range up to 3x the Bank of England base rate (at the time of writing, the BoE base rate is 4%, so stress tests could be around 12%).
For example, if your monthly mortgage interest was £500 per month, then the lender would expect the rent to be between £625 and £750. Lenders will have their own criteria and requirements (such as maximum loan to value and maximum amount of borrowing).
If you are unsure you should speak to a mortgage broker to see which lenders are willing to lend and what deals you might be able to get.
Leverage
By using a mortgage, investors use debt to leverage their property purchases. For example with a £25,000 deposit a bank could loan you up to £75,000, so you could buy a property worth up to £100,000 – more than you could afford to buy/invest in cash.
This leverage is known as the loan-to-value (LTV). Buy-to-let mortgages typically require at least a 25% deposit, i.e. a maximum of 75% loan-to-value.
The reason for this restriction is that leverage is risky. By leveraging your purchase, you are increasing your exposure to potential gains but also potential losses. By having a larger deposit, and reducing your loan-to-value, you are reducing risk. For example, if you purchased a property for £100,000 and the property price increased by 10% then you would make £10,000. However, if the property price dropped by 10% to £90,000 you would lose £10,000.
If the property price drops by more than the deposit you have put down, then you will be in negative equity and will have to pay back more than the property value.
Taxation and legislation
Broadly speaking, policy and legislation relating to buy-to-let are becoming more favourable for tenants and there are stricter rules and increased taxes for landlords.
It is your responsibility to ensure your legal obligations are being met so if you are ever unsure, check first! Asking other landlords can be helpful but be wary as they might be misinformed. It is best to find official government guidance or ask for legal or tax advice as required.
For further information on income tax see the example section below – also see the government guidance here.
Responsibilities
As a buy-to-let investor, you need to stay informed of changes as these affect your legal obligations and your profits. For example, landlords must perform a gas safety check annually and electrical safety checks every five years. Both of these cost money, reducing your profit, and certificates must also be provided to the tenants.
You are 100% responsible for your tenants’ safety during their rental of the property. Even if you use an agent, the liability remains with you. If a safety check is not complete and that leads to someone getting hurt it will be you answering questions, even if you instructed the agent who failed to do it. These responsibilities should not be treated lightly and you need to make sure your tenants are kept safe.
How to let
The government has released a How To Let Guide which details many of your legal obligations as a landlord and some best practices – this is for England only but much of the guide also applies across the UK. You should familiarise yourself with your responsibilities – such as what to do with a tenant’s deposit.
There are some regional differences across the UK – Scotland has been stricter, introducing landlord registration and additional responsibilities compared to England.
Mortgage interest rate relief
The change to mortgage interest rate relief means that landlords can no longer claim full tax relief on their finance costs (mortgage interest payments, loans and overdrafts).
The tax relief is now restricted to the basic rate of income tax (20%) and is granted on the lower of:
- Finance costs – mortgage interest payments, loans and overdrafts.
- Property business profits – profits made in the tax year after bought forward losses.
- Adjusted total income – income that exceeds your personal allowance.
The tax relief changes have mostly impacted those who are higher earners and also have property income in addition to their salary. There is an example property, with some of the differences for basic and higher rate payers in the section below.
See here for more information on the tax relief changes.
Stamp duty land tax (Transfer of ownership)
The section applies to England only – there are regional differences.
- Scotland has Land and Buildings Transaction Tax.
- Wales has Land Transaction Tax (LTT)
You may need to pay stamp duty land tax when ownership of a property is transferred. What you pay depends on the chargeable consideration, even if no cash changes hands there might be a liability to pay, usually, if the property has a mortgage. The current threshold for residential property is £250,000 and the rates increase from 5% up to 12% depending on the transfer value. Rates are even higher if you already own residential property, an additional 3% per band!
When thinking about transferring property between spouses (commonly asked on the subreddit), stamp duty land tax will usually be due as the partner is taking on liability for the mortgage payment.
Limited companies
With the taxation and legislation changes, investors looking to reduce their liability might consider starting a limited company. There are many factors which will contribute to a decision to form a company and this should not be done without taking advice, both from a financial and legal perspective.
Transferring residential properties from your personal name to a limited company has additional costs because the stamp duty land tax is due on the market value of the property, not the chargeable consideration.
As a director of a limited company, you will have additional responsibilities and legal obligations which you need to abide by. Limited companies also come with additional accounting and reporting obligations, as well as more expensive mortgages, and so should not be considered lightly.
Other considerations
Emotional and well-being cost
Are you cut out for buy-to-let? Do you think you are the right kind of person to deal with lots of random problems, some little, some large?
From tradesmen to tenants, your patience will be tested. Good management comes down to being organised and motivated. Sometimes, you do not need to do a lot, and other times you may need to work through a series of problems. It helps if you can treat this methodically and logically, and try to not get too emotionally involved – this is hard!
Are you happy to take on this work in addition to your full-time job? Can you cope with it? Be realistic and don’t stretch yourself too far.
Tenants are a mixed bag
Have you heard horror stories? Be very careful selecting tenants. Do thorough credit and background checks. Do not skimp, pay to get this done by a company that does this kind of thing regularly and if you use an agent, talk to them, and get their opinion on your potential tenants. If you can, call the tenants yourself, and get an insight into their character, everyone has different personalities.
Whilst it is rare to get really bad tenants – think extreme property damage such as pipework removal. Usually, the worst case is that they do not really look after your property very well. You may need to pay for renovation or repairs and make a claim on the deposit – another reason to ensure you place the deposit in a TDS.
If you are very unlucky (or lazy in your background checks) you could end up with nightmare tenants. Evictions and court dealings are not enjoyable, are a slow process, and will reduce your profit and willingness to continue with buy-to-let investing.
Buy-to-let Examples
Below we have an example buy-to-let property and demonstrate the differences between a basic rate taxpayer and a higher rate taxpayer (for the tax year 2023/2024).
Disclaimer: This example is for educational purposes only and does not constitute professional or financial advice. Conduct your own due diligence or consult a licenced financial advisor before making investment decisions.
Our example property is purchased for £100,000 with a £75,000 interest-only buy-to-let mortgage (75% LTV, 5% interest rate over 30 years) and is held in a single person’s personal name. We assume the rent to be 150% of the mortgage interest payment and include some of the expenses you might have throughout the year, including the legally required gas safety check and electrical safety check.
The mortgage interest tax relief, the change that caused a stir for higher-rate landlords, is restricted to the basic rate for income tax. The reduction is calculated as the basic rate (20%) from the lower of:
- Finance costs – mortgage interest payments in the year and any other finance costs bought forward.
- Property business profits – profits in the tax year after including any brought forward losses.
- Adjusted total income – income that exceeds the personal allowance.
In the following example, you will see how this change affects a basic-rate taxpayer and a higher-rate taxpayer.
| Income: | ||
| Rent Received | £5,625.00 | |
| Gross Income | £5,625.00 | |
| Expenditure: | ||
| Mortgage Interest Payments | £3,750.00 | Interest-only at 5% for 30 years. |
| Repairs and Maintenance | £ 0.00 | |
| Letting Agent Fees | £ 675.00 | |
| Legal and Accounting Fees | £ 250.00 | |
| Travel Expenses | £ 0.00 | |
| Ground Rent / Service Charge | £ 0.00 | |
| Landlord Insurance | £ 0.00 | |
| Council Tax | £ 0.00 | |
| Electrical Safety Check | £ 50.00 | A legal requirement every 5 years (£250). |
| Gas Safety Check | £ 80.00 | A legal requirement every year. |
| Total Expenditure | £4,805.00 | |
| Net Profit | £ 820.00 | |
| Taxable Profit Calculation: | ||
| Net Profit | £ 820.00 | |
| Interest Costs | £3,750.00 | The interest costs are no longer tax deductible so are added back. |
| Taxable Profit | £4,570.00 | |
| Income Tax Calculation: | Basic Rate (20%) | Higher rate (40%) |
| Taxable Profit | £4,570.00 | £4,570.00 |
| Income Tax | £ 914.00 | £1,828.00 |
| Interest Tax Relief (20%) | -£750.00 | -£750.00 |
| Total Taxation | £ 164.00 | £1,078.00 |
| Net Profit | £ 820.00 | £820.00 |
| Taxation | -£164.00 | -£1,078.00 |
| Cash | £ 656.00 | -£258.00 |
With expenses and income being equal, depending on if you are a higher rate or basic rate income taxpayer, this property could be either profitable or unprofitable.
This example does not include all costs. Usually, costs can be broken down into one-off or ongoing. The following list includes some costs you should consider:
Costs
One-off costs
- Deposit – usually 25% minimum (so 75% LTV)
- Mortgage fees
- Legal fees & searches
- Surveys
- SDLT (England) / LBTT (Scotland) / LTT (Wales)
- Estate agent fees
On-going costs
- Gas & electrical safety certificates
- Repairs & maintenance
- Tenancy creation, investory check-in & check-out, credit & background checks
- Buildings & contents insurance
- Landlord insurance
- Boiler cover
- Accounting fees
- Smoke & Carbon Monoxide alarms
- Fire extinguishers & fire blankets
- Void periods (empty property, no income & bills to pay)
- Ground rent / Service charges / Factor fees (Scotland)
- Letting agent fees
Also excluded from the example are the potential gains, or potential losses, from capital growth. This is the long-term objective of a buy-to-let investment and is often where most of the profits are made by investors. This extra money can be accessed by refinancing the buy-to-let property but this means that the money is illiquid and is not accessible until some time after the initial investment has been made.
Can you still make money?
Buy-to-let vs Index Investing
A lot of new investors post in UKPF to discuss buy-to-let and often think it’s ‘easy money’. You might know people who ‘made bank’ – maybe an uncle or a friend of your parents. It’s true that in the past it was easier: lenders were generous, rates were attractive, legislation was looser and taxes weren’t as punitive.
Times have moved on and things have changed.
It is important to say that yes, you can still make money with buy-to-let. There are experienced landlords out there with healthy property portfolios that make good returns. There is no reason you cannot become like them but you have to be willing to learn.
We hope the example above demonstrates that buy-to-let is not a ‘get-rich-quick scheme’ and that the cash you actually get to put into your pocket can sometimes be rather underwhelming.
UKPF does not hate buy-to-let however there is recognition in the community that there are far easier ways to make money.
Buy-to-let questions come up reasonably regularly on UKPF. Often the community steers the post toward passive index investment and comparisons are often drawn between the two. However, it is fair to say they are very different.
The following post on r/FIREUK is good if you want to look at some numbers:
You can also search r/UKPersonalFinance for ‘BTL‘ or ‘buy to let‘ for a variety of posts with many different opinions. It is widely accepted that index funds are a far simpler introduction to investment for newcomers.
Real Estate Investment Trusts (REITs)
Real Estate Investment Trusts (REITs) are a company, or group of companies, which are a property rental business. The REITs have exposure to the property market because they own a portfolio of properties, which can be residential, commercial or even land.
You can invest in a REIT by buying its shares which are listed on the stock exchange. By buying the shares, you are buying a piece of that property portfolio without all of the hassles of managing it yourself. You can buy the shares to own a slice of tower blocks, housing estates, warehouses, distribution centres, hospitals, hotels, shopping centres, theme parks, car parks and much more!
This is great for several reasons:
- The management team look after it all for you – the REIT is run as a property business.
- REITs are exempt from corporation tax – both on rental income and capital gains, which means more dividends for you.
- The REIT must distribute at least 90% of its profits – the rent and profit from sales in the form of dividends.
- Dividend distributions are subject to only a 20% withholding tax.
- Dividend income is treated as property income, however…
- If you buy and hold the REIT’s shares in an ISA you pay no tax on the dividends.
There are many different UK-listed REITs and it can be confusing to choose between them. These days you can pretty much invest in everything through a tracker fund but you should spend some time looking at each REIT and how it invests its capital. REITComparison has a useful list of all UK REITs and a handy guide for some additional information. There are even videos on YouTube if that’s more your thing.