Is Buy-To-Let An Expensive Mistake?

Is Buy-To-Let An Expensive Mistake?
Lembeh Straights by Julian Cohen. Why?

Since the dramatic pension changes announced in the recent budget, people are considering withdrawing their SIPP money and re-investing it in buy-to-let property

Buy-To-Let Is Back On The Agenda

Pull Out Your SIPP Money For Buy-To-Let Property

From April 2015, once you're aged 55, you’ll be able to withdraw your whole pension fund and do what you like with it.  It’s really got people thinking about buy-to-let property.

As a nation, we love investing in residential property, and buy-to-let in particular.  So it’s a natural conclusion that as you can’t invest in buy-to-let property within your SIPP, the thing to do will be to withdraw the cash and invest in buy-to-let property outside of your SIPP.

On the face of it, buy-to-let would seem to make sense from two perspectives:

  • Growth in property value will build your wealth outside of your pension
  • Rental income could be higher than the present pitiful level of annuity rates

HMRC Will Slash The Cash You Have Left For Buy-To-Let

There's a huge downside in withdrawing your pension fund to reinvest in buy-to-let.

Apart from the 25 per cent ‘pension commencement lump sum’ that’s tax free, the rest of your withdrawals will suffer Income Tax at your marginal rate in the tax year of withdrawal.  In effect, the whole of your withdrawal is treated as ‘income’, which is added to any other income you may have from your work or your investments. 

In reality, even a relatively modest withdrawal, perhaps only sufficient for a deposit on a buy-to-let property could bump into a tax charge of 40 per cent.  The current maximum tax charge is 45 per cent (in the tax year 2014/15), and if we see a change of Government next year, this could increase to 50 per cent by the time you get access to your money.

It goes without saying that losing almost half your money before you get started is a massive disadvantage.  But that’s just the beginning.

There's A Lot Of Costs Associated With Buy-To-Let

Click the image above for a great calculator that'll work out the net return from your buy-to-let property

Before rushing to contact your SIPP operator to authorise the withdrawal, it’s not just Income Tax that’ll reduce the amount of money you’ll have to invest in a buy-to-let property.

There’s stamp duty on the value of the purchase, which starts at 1 per cent and could be as much as 7 per cent on high value properties. 

You’ll bump into acquisition costs, such as conveyancing fees, surveys, searches and other disbursements.

Chances are your property will need some work doing on it before it’s rentable.  This area often accounts for a major drain on a developer’s budget.  Rarely does the work come in at or below budget, so make sure you set aside a sizeable contingency fund in case of unforeseen expenditure, or simply because you want to ‘spend a bit more to make it really nice’.

As an alternative to traditional buy-to-let, if you’re intending to purchase property to let to more than one person or family in the form of a ‘house in multiple occupation’ (HMO), you could bump into further costs which could include a license.

Unfortunately, the costs don’t end once you’ve bought your property.  You’ll have on-going outgoings such as repairs and maintenance, though some of these may be covered by insurance.  So make sure you factor in the cost of paying for good quality cover, and that isn’t cheap. 

An important and often over-looked area is ‘rental voids’.  Sadly, you can’t avoid the gaps, for it’s almost impossible to co-ordinate it so that the very day that one tenant leaves, your next tenant moves in.  It’s not unusual for the odd month or two to slip by, slashing your net return by 10 per cent or more.  And in the case of HMO property with multiple tenants, you’ll constantly have to line up tenant replacements or your income is going to suffer appreciably.

Given the hassles, you could hand the whole thing off to a good quality letting agent.  But they can demand up to 15 per cent of the rental income for the privilege of giving you an easy life.  The alternative is that you do-it-yourself.  Don’t under-estimate the time this will take, and as they say, time is money.  If you enjoy doing this sort of work, it’s no problem.  But as you’ve reached 55, perhaps you want to take life a little easier and enjoy the fruits of your labours during life’s longest holiday, rather than taking on a new job as a property manager.

Across the UK, the average net rental yield is around 3 to 5 per cent.  Your net return on investment could be improved if you take out a mortgage to complete the purchase, assuming you qualify for it.  But if mortgage rates rise, which they will do in the future, you could see much if not all of your net rental return wiped out altogether.

Buy-To-Let Is Not All Doom And Gloom

You have the prospect of capital growth in the value of your buy-to-let property.

In the year to February 2014, the Office of National Statistics reported UK house prices increased by 9.1 per cent.  In London, the rise was a staggering 17.7 per cent.  But if you do make a decent capital gain, unfortunately, it’s not all yours.  You can bet your life HMRC will come banging on your door for Capital Gains Tax, currently 40 per cent (in the tax year 2014/15).

A Comparison Between Buy-To-Let And SIPP Investment

Apart from stockmarket dividends, money invested in your SIPP grows free of Income Tax and Capital Gains Tax, but as you’ve seen above, your buy-to-let property is taxable.  For this reason, you should run a proper comparison, taking into account all the costs, and most importantly, all the taxes.  Here’s a rough guide.

If you can earn 10 per cent per year leaving the money in your SIPP, taking into account costs and taxes of withdrawing your money from your SIPP and investing the net proceeds in a buy-to-let property based on the average UK house price, you’ll have to make a net return on investment of almost 40 per cent per year to be better off.

Even in the current rising market, most experienced property people would accept that a net return on investment of 40 per cent per year is way beyond what’s generally possible.

Three Ways To Earn 10 Per Cent In Your SIPP

  • Crowdfunding platform ThinCats has delivered a weighted average interest rate of 10.61 per cent per year (from December 2011 to April 2014)
  • Granting loans to businesses from your SIPP can earn at least 10 per cent per year (some SIPPclub members are currently earning 16 per cent per year on their SIPP loans)
  • The fixed interest opportunities in our Invest area can earn up to 13.8 per cent per year

All of the above examples include the benefit of protection for your money with additional security, usually property.  None of them require much of your time.  And perhaps the most pleasing aspect is that you won’t receive any unwanted phonecalls late on a Sunday night from a tenant, moaning that the heating has broken, or a pipe is leaking!

Sometimes, it pays to keep it simple.

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