Investing in buy-to-let property is no longer a quick money-making scheme. Nowadays, buy-to-let landlords view their investments as long-term projects that generate steady income and capital gains. Just like any other investment, there will be ups and downs along the way. Unfortunately, the past year has been particularly challenging.
Interest rates on buy-to-let mortgages have been on the rise since the beginning of 2022. The ill-fated ‘mini-Budget’ presented by Liz Truss in September caused a significant jump, and the rates have remained volatile ever since. This means that the cost of new loans is higher than what landlords have been accustomed to during the years of ultra-low interest rates.
However, despite these challenges, there is still hope for buy-to-let investors. The property market has experienced strong growth in recent years, and the demand for rental properties continues to outweigh supply. In the long run, this imbalance should work in favor of buy-to-let landlords. But how can they navigate the higher interest payments and keep their businesses thriving?
Landlords have several options to explore. They can raise rents, pay down debt, sell their properties and exit the market, or choose to incorporate their businesses by buying properties through a limited company.
Raising rents may seem like an obvious choice, and many landlords have already taken this route. Data from Rightmove shows that average rents outside London increased by 9.7% last year, reaching a record of £1,172 per month by the end of 2022. Outer London rents hit a record high of £2,480, and inner London rents exceeded £3,000 per month for the first time. However, there is a limit to how much tenants can afford, and landlords need to consider alternative strategies.
In the current economic climate, paying down debt may not be a feasible option. In fact, leveraging to expand property portfolios can still be a sound decision, given the high demand for rental properties in many parts of the UK. A survey conducted among Landlord Leaders in the second half of 2022 revealed that 80% of professional landlords and 40% of part-time landlords had already purchased or planned to buy more properties. Furthermore, 68% of all landlords had or intended to invest in upgrading their rental stock to comply with potential changes to Energy Performance Certificate rules. These statistics demonstrate that landlords are in it for the long haul. Selling properties could be a last resort for many, considering the potential for long-term success.
This brings us to the concept of limited company buy-to-let.
Over the past five years, the reduction in tax relief on buy-to-let investments held under personal names has led to a surge in landlords opting for limited company buy to let. According to data from Companies House, the number of registered companies has doubled to over 300,000 between 2017 and October 2022. The recent increase in borrowing costs is likely to further support this trend, as the tax benefits of incorporation can be highly appealing.
Within a limited company structure, landlords can still offset 100% of their interest payments against their tax bill. This relief is no longer available for personal buy-to-lets. Rental income is taxed at a lower corporation tax rate of 19% to 25%, as opposed to a landlord’s personal tax rate. This makes incorporation particularly attractive for higher (40%) and top rate (45%) taxpayers. Limited company buy-to-lets also offer more flexibility, allowing owners to access property equity through director’s loans, among other benefits.
However, it is essential to consider the potential costs associated with incorporation. Each individual’s circumstances are unique, and it is the responsibility of tax advisers to calculate whether the benefits outweigh the costs.