Why buy-to-let is still an opportunity for some, but only for the prepared

Investors’ Chronicle declares buy-to-let, still an investment opportunity

Is buy-to-let dead? It’s a phrase we’ve seen written in many articles in the industry and financial press. There’s no doubt the easy money is no longer there to be made. The industry has changed under a plethora of government regulations and taxation changes.

For years now, the narrative around the UK’s buy-to-let sector has been endlessly negative. The Section 24 tax change restricting mortgage interest relief, taxing turnover rather than profits, started it all off - it was the killer blow. 

The rest is taken up by rising interest rates, an expanding regulatory burden, particularly the Renters’ Rights Act which is about to be implemented. Combine this with the looming EPC deadlines which will require more stringent energy efficiency standards, and you have the perfect storm of negativity.

There’s still hope

Markets rarely move in one direction; things don’t stay the same indefinitely. As Hugh Moorhead points out in a recent Investors' Chronicle article, periods of stress often create the conditions for future opportunity. 

The private rented sector (PRS) in the UK is no exception, as the saying goes: history does not repeat, but it does rhyme. The environment has changed, but for those who are prepared to adapt, the opportunity remains, but in a different way, not as it was fifteen years ago.

Under a highly regulated sector, buy-to-let (BTL) is no longer a passive, part-time “armchair” investment. It demands something altogether more hands-on. We’re seeing the professionalisation of the PRS in England. 

Landlords leaving

Moorhead cites two landlords who want to leave the sector: Richard a 40-year BTL veteran and Julian with a 7-apartment property in Leeds. Richards says, “The government is making it impossible for me to carry on”, citing the tax and EPC changes as well as the looming Making Tax Digital. 

Julian says he “absolutely would” consider selling, “My wife is for it, but recent valuations are very good.” Julian is most concerned about the Renters’ Rights Bill [Act] and says, “It’s now basically impossible to get rid of poorly behaved tenants”. 

Similar sentiments are expressed by landlords across the industry, and many are acting on them, selling down properties or selling up entirely. Moorhead cites Pegasus Insight and the NRLA when he claims that around 50 per cent of landlords aim to do just that in the next 12 months.

A shrinking market

There is no point pretending otherwise, says Moorhead: the sector is in retreat, it’s been shrinking for several years and more recent events like increasing interest rates and other operating costs have added to the pressure on landlords, hastening this exodus. 

For higher-rate taxpayers in particular, the economics of BTL have fundamentally altered for those with leveraged ownership. The result is a steady erosion of net yields – under Section 24, some landlords are finding themselves paying tax when their portfolio is loss making.

At the same time, compliance challenges continue to increase. Licensing schemes, deposits and inspection regimes, HMO and safety regulations and the looming EPC “C” rating requirement in 2030 presents a significant workload and additional capital costs. This is particularly acute for those with older Victorian era rental properties.

Faced with these burdens, is it any wonder many landlords have already done so, or are considering “throwing in the towel” , selling up and having an easier life?

The supply equation

It tends to be the small-scale landlord, often the so called “accidental landlords” with one or two properties who reason, the end just doesn’t justify the means. The returns they are seeing for their effort, and additional investment they might need to contribute, are no longer worth the hassle.

Despite the government’s stated aims to the contrary, housebuilding continues to fall short of its targets. But the population continues to grow: inward migration, and changing household formation (divorce, later marriage, longer lives and more single living) sustain a high demand for rental accommodation. 

And renting continues to be the only option for many young people. Affordability is a major constraint for many unless they get family help. House prices and mortgage deposits keep people out of the home ownership market for much longer than was the case thirty or forty years ago.

The result is a rental market that’s structurally imbalanced, and one that successive governments have failed to properly tackle. As landlords exit, rental supply tightens further driving up rents beyond the reach of some would-be tenants. It has even made some jurisdictions go for the nuclear option: rent control.

That’s a short-term solution: history shows that previous attempts to artificially suppress rents tend to make the problem worse by discouraging investment and increasing landlord exits. Whether or not such a policy is implemented in England, the underlying demand / supply imbalance is unlikely to go away.

Economies of scale and incorporation

This is where a change of strategy is required: go bigger to survive and thrive in the new environment. Enterprising portfolio landlords (those with multiple rental units and HMOs) are expanding, and significantly, incorporating.

Incorporation is the most significant structural shift in the sector in recent years, a response to Section 24. The tax system now provides a sharp divide between individual and corporate ownership. For higher-rate taxpayers in particular, their inability to fully deduct mortgage interest as a sole owner has decimated their returns. 

However, by using a limited company they are in a completely different tax regime. Finance and other costs become fully deductible while profits are subject to corporation tax rather than income tax. 

Raising finance is a little trickier and mortgage rates are typically higher, which tends to exclude the small-scale landlord from incorporation. Although there are additional costs associated with extracting profits from the company, the overall post-tax position can be materially more favourable—especially for those re-investing profits and building or maintaining larger portfolios.

Transferring an existing portfolio into a company can be problematic as capital gains tax (CGT) and Stamp Duty (STLT) mitigate against it, so it suits those who are investing in new assets. And there are other advantages to incorporation, such as inheritance tax (IHT) planning which allows families to have incremental share ownership. 

The practical effect is that the market is tilting towards scale. Smaller landlords operating on thin margins are being squeezed out, while better-capitalised investors, often using corporate structures, are in a stronger position to expand.

Regulation – a headwind or a tailwind?

The regulatory environment is becoming much more demanding. The Renters’ Rights reforms will complicate re-possession. EPC requirements will necessitate further investment and compliance obligations generally will continue to expand adding to administrative time and effort.

In short, these are clearly headwinds. They increase costs and introduce uncertainty and add to the workload of managing tenancies.

But there is another side to this. Regulation raises barriers to entry and excludes the amateur contributing to the contraction in supply. So, those landlords willing to rise to the challenge, to meet the new standards, will see reduced competition and possibly an opportunity to buy properties at lower prices.

Full-time as opposed to part-time landlords will see the opportunities increasingly concentrated in areas where active management can make a difference. That may include higher-yielding regional locations, multi-unit (HMO) properties, and serviced accommodation. 

Combine those with acquiring properties requiring refurbishment, particularly where improvements can enhance energy efficiency, not only will the strategy add value to the portfolio, but it can also be done at lower cost.

Returns are less likely to come from passive investment. It necessitates a business philosophy, active management, buying well, investing to meet high standards, carefully selecting tenants, treating them as valued customers and maintaining a disciplined approach to costs and financing.

The opportunities in buy-to-let are still there

For some investors, particularly if they are seeking a hands-off approach, the sector may no longer be suitable. But you should not conclude from this that buy-to-let is “finished” is “dead”. 

What is happening is not decline so much as re-configuration. Incorporation is available and changes the landscape for professional portfolio landlords, not so much for the small-scale landlord / amateur investor. 

The sector will be smaller, more professional, and more demanding. Those who remain, with a clear vision as to what’s required, with adequate capital, and a commitment to meet the new compliance standards, may find that the competitive landscape is more favourable than it has been for years.