Saturday, 10 October 2015

Removal of higher rate tax relief from buy to let mortgages: The tip ofthe iceberg?

Good afternoon ladies and gentlemen, my name is Simon Shinerock, I'm the Chairman of Choices estate agents and as you can see, I am a fan of social media, so if you get nothing else from this session, remember to follow me on Twitter!

I'm here today to talk about the removal of higher rate tax relief from buy to let mortgages and to discuss whether this restriction is the start of a longer term tightening of the buy to let market with more restrictions to come.

But before I start I would like to begin with a story, a story which I think has relevance to today firstly because it deals with change and secondly because it had another point go make which is revealed at the end.

Dr Harold Urey was a scientist who became involved in what was know as 'the Manhattan project' this project brought together some of the worlds greatest minds and resulted in the development and deployment of the Atomic bomb, the same bombs that were dropped on Nagasaki and Hiroshima finally bringing to an end the Second World War.

After the war ended Dr Urey realised that the people were frightened of this new technology and partly to allay their fears and partly as a method of personal catharsis, he decided to embark on a nationwide series of public lectures aimed at reassuring the people by explaining how nuclear power could be used for the public good and not just as a weapon of mass destruction.

During this tour he was accompanied by his Chauffeur who listened to everyone of his talks in the towns they visited together. One day to pass time Dr Urey asked his Chauffeur if he ever got bored listening to the same speech over and over again.

'Oh no' said the Chauffeur, 'I never get bored, I love your talks' ' but why said Dr Urey? You have heard them so many times' 'Well said the Chauffeur, I just love the way you communicate with the people, I see their faces and how scared they are when they arrive and then I see the fear gradually disappear as you explain things they never understood before. You are a great communicator Dr Urey and I genuinely never get bored listening to you, in fact I wish for just once in my life that I could communicate like that but I'm just a humble Chauffeur and I never will'

Dr Urey was really touched by the words of this un-presuming man and he insisted, there really was nothing special about him when it came to communication. The Chauffeur laughed nervously and said 'no Dr Urey, your are a scientist, a man of great learning, I could never communicate the way you do'

'Nonsense' said Dr Urey and to prove it to you, when we get to the next town, you can do the speech instead of me, you have heard it so many times you must know it off by heart by now, no one knows me there, you can do the speech and be Dr Urey and I will sit in the audience and be the Chauffeur'

The Chauffeur protested but Dr Urey was determined and secretly the Chauffeur was excited as well as nervous about the prospect. So when they got to the next town sure enough the Chauffeur did give the speech and to his amazement the audience responded to him just like they did to the great man, perhaps even a little better, everything was going perfectly until he got to the end, the bit he was dreading the most, question time.

He took a deep breath. 'So', he said, 'I hope you have all enjoyed my talk today but before I go I'd like to ask you if you have any questions' Silence hung in the air, no one said anything, then, just as he was about to let out a sigh of relief, a man at the back stood up.

'Dr Urey' said the man 'that was a brilliant speech and I now understand things I never thought I would understand but I do have one simple question that is bothering me, please could you explain the difference between Nuclear fission and Nuclear Fusion'

The Chauffeur smiled benevolently at the man 'My good sir', he said 'you are totally right, that is a really simple question and to show you just how simple it is I'm going to have my Chauffeur answer it'

So Ladies and Gentlemen, I want you to know that I come here today not as an expert but as a Chauffeur no more no less someone who has watched things happen again and again and has a story to tell, so on with the story

The most important question we need to answer is never what or how but why. Why do we buy property as an investment, is it to make money or is it for more important reasons like financial freedom and independence. Owning property is or should be a means to an end, not an end in itself. In today's world it's very hard or impossible to achieve freedom and independence through work alone and for many, buying property has been and still is the only viable way of doing so.

So I would like to share with you some of the reasons why I own property as an investment, so I can have time to do the things I love to do. To go out there and enjoy my life because for me that's what it's all for. But this isn't all about me, this is about a serious issue and time is short so let's move on

Ok, no more fun and games, to work. So we need to consider the impact of the removal of higher rate tax relief on mortgage interest in stages from 2017 to 2020. There has been a lot of confusing nonsense written about this change on both sides of the debate but In simple terms it will mean for every £ a higher rate tax payer pays in interest on a buy to let mortgage it will cost them an extra 20p or 25p depending on the rate at which they pay.

So in the worst case scenario, at current rates of interest, a landlord with a £100000 mortgage paying 4% £4000 interest, will see their tax relief go down from £1800 to £800. So it will cost them an extra £1000 PA, if interest rates double the cost will double, it's as simple as that. The effect of this change on the market remains to be seen, we will look at what I think in a moment  but let's briefly look at what we are being told is the reason for the change

The Government and people like Tony Hazell, a FT and Daily mail columnist would have us believe this change is needed in order to level the playing field between property investors and first time buyers. The Bank of England is quoted as saying the buy to let boom has the capacity to destabilise the market. So are these things true, is it really in the interests of society and the greater good that these changes are being made and if so should we all suck it up and stop bleating.

Well let's take Tony Hazell for example and look at his real agenda, in an article reported in Estate Agent Today this morning he is quoted as saying

'If I borrowed money to invest in an Isa or pension, then I would not make a profit from the income either once I had paid the interest on the loan. Why should landlords be immune from the rules governing businesses and investments – that is, that you are not guaranteed to make a profits" he asks in FT Adviser.

He says buy to let investors have, contrary to some suggestions, enjoyed "lavish tax perks" and are operating in a sector which is not under pressure.

He says almost 20 per cent of home loans in July were to landlords with buy to let lending growing by 33 per cent in the past year to stand at £1.6 billion. "Such has been the rush to invest that the Bank [of England] has warned it could amplify a boom/bust cycle" he says.

Sounds very convincing doesn't it however as with most people with a hidden agenda, it's not what they say that counts it's what they don't say and what you don't know that really counts.

In Tony Hazell's case, the likely reason he wants to see Buy to let penalised is that he represents the interests of financial advisors who make a living selling collective investments, a sector that has lost out to BTL.

I'm sure he knows very well that a pension can borrow money and the interest it pays is a fully deductible expense for tax purposes, the same goes for other collective investments. So as an investor, if you put money into a fund that borrows money you don't need to in order to gain the additional buying power with its risks and rewards. As I say, I'm sure Mr Hazell already knows this and that BTL does not guarantee a profit but people don't always come up front with their agendas

If you take the Governments position you see a similar deceitful theme of sleight of hand and misdirection, perhaps Derren Brown was their advisor in coming up with their line on this issue.

In yesterday's Letting Agent Today we read

'The government is ruling out any re-think on its proposals to reduce buy to let tax breaks from next year.

The Financial Secretary to the Treasury, David Gauke, has written to the Residential Landlords' Association to emphasise the determination of the government to plough ahead with the changes, first announced in July by Chancellor George Osborne.

Gauke's letter is uncompromising, saying the Osborne proposals are essential to establish "a fair tax system".

Gauke's letter says: "By restricting cost relief to the basic rate of income tax, all finance costs incurred by individual landlords will be treated the same by the tax system."

The RLA, in an earlier letter to Gauke, had made the point that the private rental sector should be treated like any other business for tax purposes, IE be taxed on profit not on turnover

Gauke's response to this point includes this key statement:

"Landlords will continue to get full income tax relief on the costs incurred in letting out a property, such as letting agency fees and replacing furniture, as others do on the costs they incur in carrying out a trade. Finance costs are different as having a mortgage on a property also allows the landlord to purchase a more expensive property and incur larger gains on the investment than they would without the mortgage. The government wants to rebalance relief for these finance costs and ensure that all individual landlords get finance cost relief at the same rate."

Gauke insists that the phased reduction on tax relief for landlords will not lead to a rise in rents "due to the small overall proportion of the housing market affected."

The reality is of course that the same rebuttal applies to this argument as to Tony Hazell's, which is that finance costs are still fully relieved, albeit indirectly, when you invest in a company or collective fund, so where is the level playing field? Equally missing from the pro argument is the fact that owners pay no capital gains tax when they sell, so unfair to Landlords then!

Some people have suggested Individual landlords should set up limited companies and use them to borrow money to BTL thereby retaining full tax relief. There are many reasons why this strategy won't work for most people for whom it will be too expensive and too complicated.

In David Gawke's full reply you start to see the real reason for the Government's strategy becoming clear, there just aren't enough individual landlords at the moment to make a significant political difference. As a group although on the face of it we are predominantly conservative voters, we are being sacrificed, not for the greater good but in an effort to pander to a larger constituency within the electorate and to distract from the real reason for all the fuss.

The larger constituency the Conservatives are aiming at are the left of centre middle ground  vacated by the increasingly left wing Labour Party.

The real crisis is of course a building crisis, we have not built enough homes for our growing population and no amount of fiddling with the balance of power between owners of landlords will make any difference, the real solution to the crisis is to build more homes.

What I despise the most is the double standard at work here, on the one hand David Cameron is saying he wants to return us to a home owning society and is therefore penalising individual landlords, whilst on the other hand the government is incentivising institutional build to let which is clearly their real plan for the sector.

So far the returns from the sector have been too low to tempt in massive institutional investment, so the plan is to hobble the private landlord, risk the political backlash and at the same time encourage and incentivise institutions to mass build small apartments for the masses. The outcome will be the worst of all worlds, it won't encourage home ownership, it discourages those who want to better themselves and it will leave a generation with nowhere to live apart from unattractive apartments designed by bean counters.

Ok Ok, I will now get off my soap box, I have been on it for months now and it's becoming increasingly clear we are fighting a losing battle with this government, so, if the lady is not for turning we need to be pragmatic and decide what to do next

As I have speculated, this change is the tip of the iceberg, George Osbourne has said that he intends to restrict mortgages to the sector and perhaps even limit the number of BTL properties an individual may own.

So what should you do? Sell, Hold, or buy?

Well I was approached the other day by a long term multi landlord, he called me up to tell me he had decided to liquidate his portfolio. He thought he could clear £1M profit, let's look at the actual situation

Even if he cleared £1M he would have to pay 28% CGT plus fees but of course because of the negative publicity in the sector for the moment he will also have to give a 10% discount. We calculated he would actually net about £650K if he was lucky. However he then had the problem of what to do with the money. Banks are paying nothing, it's even been suggested that next year they may start charging rent on our money but that's another story. Which leaves the stock market, when I suggested we buy a roulette wheel and start picking shares he decided to reconsider and hang on for the time being at least.

You see in reality, for most people there is no real alternative to investing in property, so once these changes have been digested the market will continue to pick up while there is a way people will take it. But the market is changing and will change and not for this reason alone.

Lettings is getting ever more regulated, since October 1st the obligations placed on Landlords and their agents have increased substantially and the cost of getting it wrong has also increased. The days of the DIY landlord who cuts corners for maximum profit are numbered and rightly so, do it properly or don't do it at all, because tenants do have rights, the right to expect their landlord to give them a fair shake at least.

So everyone, not just higher rate tax payers will face increased costs be they from maintenance, compliance or otherwise.

So what will happen? What I foresee is a gradual migration of money from the south to the north in search of better value properties in hotspots offering higher yields and the prospects for higher capital growth. Right now most landlords buy in their backyard, and do everything themselves, in many areas of the south east this no longer makes sense.

However it is impractical for most landlords to buy property in multiple hotspots around the country and manage them themselves. So what I see is the gradual rise of the armchair investor who comes to companies like my own, companies who can find them properties all over the country in areas they would never dream of going on their own and take all the problems off their shoulders, giving them a central asset management service with a single point of contact and a rent guarantees well as a higher yield and property that will go up in value faster than the overvalued one in their back yard

For those of you who are interested in taking this path speak to me afterwards :) for those of you determined to continue down the DIY path I wish you all the best.

Ok folks thanks for listening, I hope you found some of the things I have said interest arousing and thought provoking at the very least and perhaps for some of you they will provide a new productive avenue down which you can go.

Before we finish, we now have a few minutes for questions, who would like to go first? Depending on the question I may have my Chauffeur answer it, stand up Matt and take a bow!


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