RENTAL INCOME – THE GOOD, THE BAD AND THE ALTERNATIVE
Historically, property has always been a sound investment. It became even more popular after the fall in equity and bond returns following the financial crisis of 2008/9. People were looking for alternatives, bank interest rates were and still are offering no real return after inflation … so many people turned to residential property investment and went down the ‘buy to let’ route to generate income.
However, as with all investments there are benefits, drawbacks and risks. If you are wondering whether a rental property is right for you, read on …
Lack of Liquidity
You have to wait to sell your property, finding a buyer isn’t always going to fit in with your need for cash. Even when you do sell, the sale of a property can be a slow process.
The cost of buying and selling property, including stamp duty, legal fees and agents commission can be relatively expensive.
When the property market is slow, it can be virtually impossible to sell, except at a greatly reduced price in relation to normal values.
It isn’t possible to sell a property in ‘bits’ to boost your income as you would an investment or take advantage of the annual capital gains tax exemption in the UK … it’s an ‘all or nothing’ scenario!
Letting property is a business in itself … it requires administrative, financial and marketing skills together with commitment and patience with the tenants… particularly during the Covid 19 pandemic when many tenants have been unable to pay their rent.
Deciding whether to manage the property yourself or to use a letting agency … around 50% of all rentals are arranged through letting agents in the hope of offering a hassle-free life for the landlord. Living close to the rental property is an advantage if managing your own rental as you are on hand to look after it and deal with tenants effectively, and of course will save on fees. Full property management can cost anything from 12% to 20% of the total rent, depending on the area and which managing agent you choose.
Choosing the right letting agent isn’t easy as the quality varies between agents, together with their fees! Many of my clients have been disappointed with service levels and are often left wondering why they pay an agent because they end up dealing with tenants’ issues directly.
It may be difficult to find tenants in areas where there is a surplus of rental property.
Evicting a tenant that is not paying the rent or trashing your rental property can be a lengthy and costly exercise. Although a landlord is protected by property law, enforcing the law may involve the services of a solicitor and court proceedings, incurring additional costs. You can take back possession of your property at the end of a fixed-term tenancy agreement, or trigger an agreed break clause with a Section 21 notice of possession. Other than that, a Section 8 eviction notice must be served when you have grounds for eviction. For example, the tenant has not paid the rent, damaged the property or is causing a nuisance. In such cases you can terminate the tenancy during its fixed term if the tenant has breached the tenancy agreement. But your tenant may dispute it, and it could go to court where you’ll need to evidence the reason for the eviction. Even then the outcome might not go your way with the effect that no order for possession is granted, especially if the tenant has remedied the breach that you relied on to seek possession. A tenant may choose to ignore the notice and a judge in court may not decide in your favour!
Age and condition of the property you buy will affect the maintenance costs and could result in greatly reduced or even zero income from the property, it is usually worth buying a newer property for renting.
Expected Rental Yields
Rental yields vary significantly between different properties and different locations. As a general rule, the larger the property the lower the yield. Also, general expenses such as the costs of agents, maintenance and buildings insurance all impact on the overall yield, reducing it on average by around 25%.
Buying in an area that will offer you the rental income you are looking for is key. The difference in the UK market is shown in the following chart. As you can see, the average rental income varies between £550 pm in the North East to £1,600 pm in London.
Average rent in the United Kingdom (UK) May 2021, by region (In GBP)
© Statista 2021
Property investment carries with it the risk of the loss of rent. As all landlords will know, tenants do not stay in buy-to-let properties for ever. After a period of time most tenants will begin to consider upsizing, downsizing, buying their own property or moving for work. When tenants do vacate a property, this often causes void periods where there is no tenant, and therefore no rental income. The other issue of course is the reliability of the tenant and the expectation that the tenant will pay the rent regularly and on time!
Void periods are without doubt one of the key factors effecting the profitability of a buy-to-let property. During a void period, properties produce no income whilst still being liable for mortgages, maintenance, insurance and other related taxes and charges. As such, extended void periods can have a significant negative impact on both the monthly cashflow and end of year profitability of buy-to-let properties.
Geography and property type can also influence average void periods. Clearly, student-lets are most attractive when they are near universities and student areas. Professional lets are best suited to city-centre or commuter locations, whilst families will want to live in suburban environments near schools and amenities.
Prospect for Capital Growth
One of the main attractions behind property purchase has been the prospect of long-term capital growth. However, even that isn’t guaranteed, it’s easy to see from the chart above that if you were unlucky enough to buy before the dip in January 2008 and sold in 2019 you are likely to have lost money, but if you were savvy enough and had the resources to buy in the dip and sold in 2020 you have bagged a return of up to 25% in that same period. That said, even the best case scenario of 25% total return in 12 years isn’t breaking any world records!
Tax and National Insurance!
You have to pay Class 2 National Insurance if your profits are £6,515 a year or more and what you do counts as running a business, for example if all the following apply:
being a landlord is your main job
you rent out more than one property
you’re buying new properties to rent out
If your profits are under £6,515, you can make voluntary Class 2 National Insurance payments, for example to make sure you get the full State Pension.
For property you own personally, the first £1,000 of your income from property rental is tax-free. This is your ‘property allowance’. Rental income from a UK property is declared on a self-assessment return in the UK irrespective of whether you are resident in the UK or another country. If the property is owned by a company, the rental income is treated the same as any other business income.
You or your company must pay tax on the profit you make from renting out a residential property, after deductions for ‘allowable expenses’. If you live in Spain, the rental income should also be declared on your Spanish Tax Return and the difference in tax paid to the Hacienda.
THIS MAKES UK RENTAL INCOME FOR RESIDENTS OF SPAIN VERY NON-TAX EFFICIENT IF THE PURPOSE OF THE RENTAL PROPERTY IS TO PROVIDE AN INCOME WHEN YOU LIVE IN SPAIN.
Not only because of income tax, but also potential inheritance tax, wealth tax and capital gains tax.
There is a much more tax efficient way of providing an income without the issues that come with a rental property … a Spanish Compliant Investment.
Spanish Compliant Investment
This type of investment is specifically tailored for those living in Spain who want either capital growth and/or income in a tax efficient way. It offers you the opportunity to pay less tax, making sure your hard-earned cash works for you not the tax man! To explain in relation to what’s available to residents of the UK, it is the nearest thing to an ISA for those living in Spain. The detail of this solution is too far reaching to include in this article, but I list below a broad outline of some of the benefits which make this a fantastic tax efficient alternative for those who don’t want the hassle and tax implications of rental property:
tax free growth whilst the money is invested.
tax efficient withdrawals/income at a time that suits you, whether it’s monthly, quarterly, annually or adhoc. When a withdrawal is made only the growth is taxed. This provides the benefit of tax deferral and can often lead to significant savings, particularly when you consider that part of any withdrawal is also deemed return of your own capital and is not taxed at all.
In most cases, the tax due is automatically deducted when you make a withdrawal and sent directly to the Hacienda, so no need to report the income on your Spanish tax return.
No Spanish inheritance tax paid on a joint life policy on first death, irrespective of the inheritance tax allowances at the time.
No need to wait for Wills to be processed on death and all the bureaucracy that comes with it in respect of either probate or the Hacienda. Proceeds from a Spanish Compliant Investment are paid out immediately and directly to your named beneficiaries, which makes life a lot easier for your loved ones in the event of your death.
If held in joint names, it would automatically continue in the name of the survivor on first death, so no issues with change of ownership or being forced to fully encash.
Wealth Tax can be reduced by up to 80% (dependant on what other income you have).
Flexible enough to change as your needs change.
Avoids the need to be reported on the Modelo 720 as this is done automatically by the provider for all their clients on one return.
At Speed Financial Solutions, our focus is to ensure that our clients are able to enjoy life knowing that they are set up in the most tax efficient way for their particular circumstances. If you are considering alternatives to rental income please contact firstname.lastname@example.org
Speed Financial Solutions are a highly qualified financial services provider looking after clients throughout Spain and the UK. We provide a discreet and comprehensive service to individuals, and our service is tailored to suit your needs taking advantage of tactical opportunities as they arise in respect of your pension planning. We seek innovative solutions for our clients and employ our skills, based on many years of experience, to apply tax legislation to your advantage. Our relationships are built on trust and mutual respect. We are ready to answer your questions, giving you the confidence you want when dealing with a sensitive issue such as discussing your pensions, investments and savings.
Our Principal, Andrea Speed, is a qualified Discretionary Investment Manager specialising in Investment and Risk, Taxation and Trusts, and a qualified Pension Specialist. Andrea is also a Fellow of the Chartered Insurance Institute (CII), which is the world’s largest professional body for insurance and financial services in the world.
Fellowship is the highest qualification awarded by the CII (Level 7) and is universally regarded as the premier qualification. It is a major achievement in the financial industry and demonstrates the acquisition of skills and knowledge at the highest of levels. Along with a Fellowship, Andrea is a CII Chartered Financial Planner.
Please take a look at our website – www.speedfinancialsolutions.com
For further information contact us on Tel 951 315 271 or 951 318 529
We are happy to discuss your own situation in more detail. One of our advisers would be pleased to spend some time with you either in your home or at our office to review your current savings, investments and pensions, so do call to make an appointment. Our Financial Review is completely free of charge and without obligation. Follow us on Facebook for regular updates.
The contents published are not recommendations or decision aids for your investment decisions and they do not constitute any type of advice. We are not tax advisers and independent tax advice should always be sought.
Andrea J Speed FPFS (DM), M.A.
Principal, Fellow and Chartered Financial Planner
Speed Financial Solutions
26 August 2021