Why Choose Buy-to-Let Property? A Comprehensive Guide

Deciding whether to purchase a buy-to-let property is a complex decision. There are various options to consider when choosing where to invest your money, such as stocks, shares, bonds, cryptocurrencies, art, or even wine. However, buy-to-let property offers unique advantages that distinguish it from other investment choices. In this detailed guide, we examine the benefits of buy-to-let property and explain why it can be a wiser choice than other asset classes.

The Resilience of UK House Prices

One of the most compelling reasons to invest in buy-to-let property in the UK is the resilience of UK house prices. The UK property market has historically shown a strong upward trend, largely driven by the under-supply and high demand for UK housing. Over the last 50 years, house prices in the UK have experienced significant growth.

According to data from Nationwide, UK house prices have increased by an average of 7.5% per year since 1973. Even during economic downturns, the UK property market has shown remarkable resilience. For example, during the 2008 financial crisis, while there was a temporary dip in house prices, they quickly rebounded and continued to grow. This resilience is largely due to the chronic shortage of housing in the UK, which ensures a consistent demand for property. This supply-demand imbalance creates a stable environment for property prices, making buy-to-let a secure investment over the long term.

In addition to the 2008 financial crisis, other historical events have shown the resilience of UK house prices. For instance, during the early 1990s recession, house prices experienced a downturn but began to recover by the mid-1990s. More recently, the COVID-19 pandemic caused initial uncertainty in the housing market. However, government interventions such as the Stamp Duty holiday and the continued demand for housing led to a surge in house prices throughout 2020 and 2021.

The resilience of house prices in the UK can be attributed to several factors:

1. Supply and Demand Imbalance: The UK has a chronic shortage of housing. According to the National Housing Federation, the country needs around 340,000 new homes each year to meet demand until 2031. However, the number of new homes being built falls short of this target. This imbalance creates upward pressure on house prices.
   

2. Economic Stability: The UK has a relatively stable economy, which attracts both domestic and international investors. The country's robust legal system and property rights further enhance its attractiveness as a safe investment destination.

3. Government Policies: Various government policies and incentives, such as Help to Buy schemes and the aforementioned Stamp Duty holiday, have supported the housing market during challenging times.

4. Cultural Factors: Owning property is deeply ingrained in British culture. Many people view homeownership as a key milestone and a symbol of financial stability. This cultural preference for property ownership ensures a steady demand for housing.

The combination of these factors and the historical resilience of UK house prices makes buy-to-let property a reliable and attractive investment option for the future.

Asset-Backed Investment

Unlike stocks, shares, or other alternative investments, buy-to-let property offers an asset-backed opportunity. When you invest your money in buy-to-let property, you own a tangible asset, the asset is what is responsible for generating the income you receive. This physical ownership provides an additional sense of security because the value of the property is tied to a real, usable asset which holds its intrinsic value because of the demand for housing in the residential property sector.

In contrast, many other investments, such as stocks or cryptocurrencies, do not provide ownership of a tangible asset. Stocks represent a share of a company, and their value can be highly volatile based on market conditions and company performance. Cryptocurrencies, while offering potentially high returns, are known for their extreme volatility and lack of intrinsic value. Property, on the other hand, is a physical asset that can appreciate over time and generate rental income, offering a dual revenue stream and generating a higher return on investment.

Furthermore, buy-to-let property offers a degree of control that is often lacking in other asset classes. As a property owner, you can make decisions regarding the management and improvement of the property, which can directly impact its value and rental income potential. This level of control is not typically available with stocks or bonds, where investors are largely at the mercy of market forces and company management decisions.

The benefits of asset-backed investments include:

1. Tangible Security: The physical nature of property provides a sense of security and stability that intangible assets cannot match. You can see, touch, and utilise the property, which adds an element of certainty to your investment.

2. Appreciation Potential: UK Property historically has been seen to appreciate over time, driven by factors such as location, investment in the local and regional area, development of the property, and demand. This potential for capital growth adds another layer of value to your investment.

3. Income Generation: Rental income from buy-to-let properties provides a steady cash flow, offering a reliable source of income. This dual income stream—capital appreciation and rental income—enhances the overall return on investment which other assets lack.

4. Inflation Hedge: Buy-to-let property can act as a hedge against inflation. As inflation rises, property values and rental income tend to increase, helping to preserve the real value of your money.

In summary, the asset-backed nature of buy-to-let property provides a unique combination of security, control, and potential for both capital growth and income generation, making it an attractive option compared to other asset classes.

Leverage through Financing Products

Another significant advantage of purchasing buy-to-let property is the ability to leverage your cash using various financing products. Buy-to-let mortgages, bridging loans, and joint ventures with angel investors can significantly amplify your budget and returns which otherwise would not have been accessible.

Buy-to-let Mortgages

Buy-to-let mortgages have become increasingly accessible to new buyers with limited capital. Introduced in the late 1990s, these mortgage products allow buyers to purchase property with a smaller deposit, making buy-to-let property more accessible.

Buy-to-let mortgages work similarly to standard residential mortgages, however, there are some key differences. Lenders typically require a larger deposit (usually a minimum of 25% of the property's value) and charge slightly higher interest rates compared to residential mortgages. However, the rental income generated from the property should cover the mortgage payments, making it a viable financing option for many buyers.

For example, consider someone who wants to purchase a £200,000 property with a 25% deposit (£50,000). With a buy-to-let mortgage covering the remaining £150,000, the buyer can leverage their initial cash to control a significantly larger asset.

If the property appreciates by 5% per year, the owner stands to gain the whole amount of the capital appreciation annually, £10,000 in this example, even though they only put down 25% of the property value using their cash. Plus this is in addition to the rental income which should yield a monthly income until the property is sold or re-financed to liquidate any capital appreciation.

Bridging Loans

Bridging loans provide short-term financing options to cover the gap between buying and selling properties. These loans are typically used for quick purchases, renovations, or to secure a property before obtaining long-term financing.

Bridging loans are more flexible and quicker to arrange compared to traditional mortgages, but they come with higher interest rates and fees which you need to make sure you understand before considering this option. Despite the higher costs, bridging loans can be a valuable tool for buyers looking to capitalise on time-sensitive opportunities or properties that require significant refurbishment before they can be rented out or sold.

Joint Ventures with Angel Investors

Joint ventures with angel investors can provide the necessary capital for larger projects. In a joint venture, multiple investors pool their resources to invest in a property, sharing the risks and rewards.

Angel investors, who are typically high-net-worth individuals, can provide the financial backing needed for the projects. These partnerships can be particularly beneficial for new investors with limited capital or experience, as they can leverage the expertise and resources of more seasoned investors. The buyer typically benefits the Angel Investor because they commit more time and hands-on work to the project while the Angel Investor provides the cash needed to finance the project which would otherwise have been inaccessible to the buyer.

Benefits of Leveraging through Financing Products

The ability to leverage, regardless of product, ultimately means you can control a larger asset base with less of your own money, potentially leading to higher returns. For example, with a 25% deposit on a buy-to-let mortgage, you can own a property worth four times your initial cash outlay, and the rental income can cover the mortgage payments and other expenses.

It is worth noting that leverage magnifies both gains AND losses, so it is essential to carefully consider the risks involved and ensure you have a solid financial plan in place. However, when used judiciously, leverage can significantly enhance the overall return on investment and is a common tool used by buy-to-let property owners.

Tax Advantages through Limited Companies

Purchasing a buy-to-let property through a limited company can offer several tax advantages. When you purchase and own property through a limited company, you can offset many of the expenses incurred in running the company against your profits, reducing your tax liability.

Operating as a Business

Operating as a business means you can deduct costs from your taxable income as other businesses would. This can include costs such as property maintenance, property improvements (e.g. extensions or loft conversions), management fees, and mortgage interest. Additionally, profits can be reinvested into purchasing more properties or other assets, further reducing your tax burden. This is in stark contrast to other asset classes, where operating expenses, if incurred, are less likely to be tax-deductible.

For example, if your limited company owns a buy-to-let property that generates £20,000 in rental income annually, and you incur £10,000 in allowable expenses (such as mortgage interest, maintenance, and management fees), your taxable profit would be £10,000. By offsetting these expenses against your rental income, you effectively reduce your tax liability.

This has become a key tool for owners in the Buy-to-Let market, especially since Section 24 came into effect in 2017, where properties owned in a buyer’s name cannot offset mortgage interest and are charged tax on the total rental income before any expenses. This change dramatically affected the profitability of many Buy-to-Let properties privately held across the UK.

Reinvestment and Expansion

Owning property through a limited company can also allow the owners of the company to reinvest profits and fund further expansion of their portfolio. Profits retained within the company can be used to purchase additional properties or other business assets, allowing you to grow your property portfolio without incurring immediate tax liabilities.

This approach enables you to leverage the company's profits for further investment, creating a compounding effect that can significantly enhance your long-term returns. By reinvesting profits, you can continue to expand your property portfolio, increase rental income, and benefit from capital appreciation.

Lower Corporation Tax Rates

Limited companies currently benefit from lower corporation tax rates compared to higher personal income tax rates, which can significantly improve your overall returns. As of the time of writing in 2024, the UK corporation tax rate is between 19-25% depending on the total profits in a tax year, compared to personal income tax rates that can be as high as 45% for higher earners.

This lower tax rate can result in substantial tax savings, particularly for owners with larger portfolios or higher income levels. By operating through a limited company, you can retain more of your profits and reinvest them into your business, further enhancing your returns.

Flexibility in Managing Investments

Operating through a limited company also offers more flexibility in managing your investments and planning for the future. For example, you can choose to pay yourself a salary or dividends, depending on your financial circumstances, which can be more tax-efficient than taking income directly from rental profits. You can also plan for succession and estate planning more effectively, ensuring a smooth transition of assets to future generations.

In summary, the tax advantages of investing in property through a limited company include the ability to offset expenses against profits, reinvest and expand your portfolio, potentially benefit from lower corporation tax rates, and enjoy greater flexibility in managing your investments. These advantages can significantly enhance your overall return on cash invested and make buy-to-let property a more attractive option compared with other asset classes.

Long-Term Financial Decision

We firmly believe that buy-to-let property is a long-term financial strategy which can provide substantial returns over time. By coupling the increase in property prices with rental income, buy-to-let properties offer a powerful dual-income stream.

Capital Appreciation

As discussed, UK house prices have shown a long-term upward trend, driven by the supply and demand imbalance. Historical data indicates that property values tend to appreciate over time, providing significant capital growth for the owner. For example, according to the Office for National Statistics, the average UK house price increased from £150,633 in 2005 to £284,691 in 2023, reflecting an annual growth rate of approximately £7,500 per year over 18 years.

By holding onto property over the long term, owners can benefit from this capital appreciation. This long-term growth potential makes property an attractive option for those looking to build and preserve generational wealth.

Rental Income

Rental income provides a steady cash flow, offering a reliable source of monthly income, which will also change based on market demands. Rental prices in the UK have also seen strong growth along with capital appreciation. For example, in the previous 12 months to January 2024, data from the Office for National Statistics shows private rental prices in the UK have seen a 6.2% rise over that period.

Combining Income Streams

By combining the two income streams - capital appreciation and rental income - buy-to-let property offers a strong return for the owner over the long term. For example, consider a buyer who purchases a property for £200,000 with a 25% deposit (£50,000) and a buy-to-let mortgage. If the property appreciates by 5% per year, its value would increase to approximately £255,000 after five years, providing £55,000 in capital growth. Additionally, assuming the property generates £12,000 in annual rental income, the owner would receive £60,000 in rental income over the same period.

In total, the owner's combined return from capital appreciation and rental income would be £115,000 over five years, representing over a 230% return on their initial £50,000 investment.

Hedging Against Inflation

Property can also act as a hedge against inflation. As inflation rises, property values and rental income tend to increase, helping to preserve the real value of your investment. We’ve seen this over recent months with the sharp rise in rental prices coming during times of high inflation throughout 2023 and the start of 2024. This inflation-hedging characteristic adds another layer of security to property investment, making it a reliable long-term financial decision.

Mitigating Risks

While property offers significant advantages, it is essential to recognise and mitigate potential risks. Factors such as market fluctuations, interest rate changes, and property-specific issues can impact the value and income potential of your property.

To mitigate these risks, it is crucial to conduct thorough research and due diligence before purchasing a property. This includes analysing market trends for property values, evaluating the condition and location of the property, and considering the potential for rental demand. Additionally, diversifying your property portfolio across different locations and property types can help spread risk and enhance the stability of your investments.

Conclusion

Buy-to-let property offers numerous advantages over other asset classes. The resilience of house prices in the UK, asset-backed investment opportunities, leverage through financing products, tax advantages, and the potential for long-term returns make property a smart choice for people wanting to maximise their money. While other investments can be volatile and lack the security of tangible assets, buy-to-let properties can provide both a stable and profitable option.

At Seven Generations, we believe property is a fantastic vehicle to create and preserve generational wealth. If you're considering purchasing Buy-to-Let property, we're here to help you navigate the market and make informed decisions. Get in touch with us today to learn more about how you can start your buy-to-let property journey.