How to overcome obstacles in complex buy-to-let

As outlined in article 2 in this special report, how to navigate buy-to-let changes, stricter underwriting criteria being imposed by the Prudential Regulation Authority (PRA), a 3 per cent stamp duty land tax (SDLT), the restriction on landlords’ ability to offset finance interest against rental income and the requirement on landlords to pay tax on their mortgage costs have all combined in the past two years to curtail buy-to-let investment.

There are some simple measures, and more complicated ones, to help buy-to-let clients remain invested and to be profitable, but often these have unintended consequences, as contributors to this guide have pointed out.

1) Raising rents

The National Landlords Association has estimated more than 400,000 landlords have been forced up into the higher-rate tax bracket since April 2017, as the changes have inflated their rental income.

A straightforward way for buy-to-let clients to be compensated for the additional cost of higher taxes is to pass the burden onto tenants. Already, according to Shaun Church, director at Private Finance, many buy-to-let investors are “looking to increase rents to compensate for the loss in revenue”.

Complex buy-to-let mortgages are often the best option for some investors, and the only option, in some cases. Jeremy Duncombe

Rents are also increasing as a result of a slight (or perceived) slowdown in buy-to-let investment appetite – Adam Smith’s basic economic laws of supply and demand apply.

Mr Church explains: “The changes are limiting landlords’ investment appetite. With fewer landlords investing in new buy-to-let properties at a time of already restricted housing supply, and rental demand remaining high, this too could result in higher rents.”

According to data from Platinum Property Partners (PPP), to offset all the measures and remain profitable, landlords would need to raise rents by at least 30 per cent.

With average UK rents at £895, this is the equivalent of a £179 per month increase on average.

The PPP data suggests higher rents may not work too well for single-occupant buy-to-lets, as few individuals could cope with such a high monthly increase.

Yet raising rates may be a viable option for complex buy-to-let structures such as houses of multiple occupation (HMOs). This is because the 20 per cent average rent increase would apply across all tenancies – meaning the total figure would be divided among the number of occupants. 

So, for example, a rise of £179 a month could end up being divided among six tenants, equating to a £29 a month increase per individual.

PPP’s research confirmed this, suggesting tenants in HMOs could better withstand a rent rise, especially as overall rents on HMOs tend to be lower than rents on traditional vanilla buy to lets.

2) Special purpose vehicles

Latest figures from HM Revenue & Customs has revealed there are fewer residential property transactions liable for Stamp Duty in the first quarter of 2017 compared to a year earlier.

The number of liable transactions with transaction value between £250,000 and £500,000 in Quarter 1 of 2017 is 10 per cent lower than Quarter 1 of 2016.

For the financial year 2016-17, the number of transactions is 2 per cent lower than in 2015-16.

This could be the result of two things. With the introduction of the surcharge on second properties, as of April 2016, many landlords sought to beat the deadline by pushing property transactions through – to avoid what might have been four or even five-figure tax penalties.

The second reason could be the rise of landlords incorporating properties into a special purpose vehicle (SPVs). This form of incorporation has proved popular among landlords since the 3 per cent SDLT hike came into effect. 

Martin Reynolds, chief executive of SimplyBiz Mortgages, comments that IFAs should have an “Understanding how limited company buy-to-let works, and the structures each lender will accept, plus how they can be set up and checked if already incorporated.”

He adds, however: “While limited companies are definitely one solution, they are not the only solution. Tax advice should be sorted out by the landlord, then the appropriate product structured by the adviser, using all the lenders available.” 

Shaun Church, director at Private Finance, is cautious about incorporating, especially for complex cases. “The only way of getting around the changes is to invest through a limited company, and these come with much higher rates of interest.

“However, there are fewer mortgages, and these come with much higher rates of interest. There are also more tax implications to consider, that make moving to a limited company structure far from straightforward.”

3) Shift to complex

Because higher-value properties have been hit the hardest since the SDLT hike was introduced, many landlords could consider diversifying away from the high-end, single-occupant residential property and towards HMOs or similar complex buy-to-let structures.

For example, HMRC figures show there has been a 14 per cent fall in transactions with a value above £500,000. 

Mr Church comments: “A healthy property market needs movement and fluidity at all levels and across all tenures, but it appears that the changes have unfairly targeted the upper-end of the market – which does little to help the cause of first-time buyers.”

Therefore, investors wanting a regular income stream without high tax burdens could consider diversifying their property portfolios will various types of buy-to-let, complex and vanilla.

“Complex buy-to-let can require a bit more work than a standard product”, says Jeremy Duncombe, director at Legal & General Mortgage Club, “and can take more time to arrange.

“However, complex buy-to-let mortgages are often the best option for some investors, and the only option, in some cases. The challenge for advisers, therefore, is to work closely with a number of lenders to see which one would be the best match for a client’s current situation, and offer the best deal.”

4) Think long-term

Mr Church also believes while the SDLT has caused a slowdown, which is “bad news for the health of the housing market”, there has been a silver lining in that investors have seen the capital value of their investment far outstrip SDLT charges.

For this reason, advisers need to encourage clients to think more long-term about the place of property in an overall investment portfolio, and how buy-to-let fits with their investment objectives.

It will be important for brokers not to overstep the market and be sure to let clients know they should take separate advice to understand the tax aspects properly. David Hollingworth

He explains: “The slower growth of high-value property prices has had a positive impact on affordability in this segment of the market. 

“According to our research, while last year’s Stamp Duty changes have left landlords and second homebuyers in the top 5 per cent of the market paying £33,639 extra tax, the resulting slower growth in house prices has actually saved them £40,827.”

As ever, the reasons for investing in property should not be made purely on the basis of short-term tax takes but for reasons of long-term financial planning.

5) Timing

Jamie Smith-Thompson, managing director of advisory firm Portafina, highlights potential obstacles with the time it can take for complex buy-to-let mortgage applications to go through.

He says: “A major challenge is getting the mortgage through the underwriter of the lending company for the complex buy-to-let client.

“The underwriting criteria is more detailed and involved than it used to be, and the client will be expected to provide a substantial amount of detailed information throughout the process.

“As a result”, he continues, “such obstacles to a smooth flow in the process can have time implications. The worst-case scenario is where the product is taken off the market by the lender before the completion of the process.

“The challenge here for the IFA is to manage the client journey as much as possible to reduce the time involved to reach a positive outcome with complex buy-to-let.”

5) Portfolio landlords

Underwriting is set to be even more complicated. Under the Prudential Regulation Authority’s new underwriting and affordability criteria, complex buy-to-let borrowers with four or more mortgaged buy-to-let properties will be classified as portfolio landlords.

As a result, they will be subject to specialist underwriting standards and it will be incumbent upon lenders to determine how to verify the number of mortgaged buy-to-let properties owned by the borrower.

Therefore, brokers must make sure their clients can furnish lenders with substantial and appropriate documentation, as well as providing as much information as possible to make the complex buy-to-let application successful. 

Information which lenders might request include:

• Borrowers’ previous history and experience in the buy-to-let market.
• Data on the borrowers’ full portfolio of properties and outstanding mortgages.
• Documentation on all the assets and liabilities of the borrower, including any tax liability.
• Paperwork outlining the merits of any new lending in the context of the borrower’s existing buy-to-let portfolio, together with a business plan.
• Historic and projected cash flows associated with all the properties.

Louisa Sedgwick, director of sales, mortgages, for Vida Homeloans, comments: “With these further changes to the way in which portfolio cases will be underwritten by lenders from 1 October this year, intermediaries will be responsible for understanding their clients’ circumstances in far more detail than previously, making buy to let mortgage applications potentially more complex.”

6) Seeking specialist advice

With tax matters making buy-to-let far more complicated, David Hollingworth, associate director, communications, for London & Country Mortgages, believes it is important for all advisers to have an “awareness of the changes and what it could broadly mean for a client”.

However, he adds: “Remember these are often complex issues and require specialist tax advice.

“It will be important for brokers not to overstep the market and be sure to let clients know they should take separate advice to understand the tax aspects properly, which will help them decide on their preferred approach.”

Indeed, overstepping the mark on tax could mean brokers and their clients are criminally liable for any tax avoidance, warns Chris Ioannou, senior IFA for Prestige IFA.

“With the introduction of the Criminal Finance Bill in September 2017, lenders and brokers could be held responsible if clients are avoiding their tax obligations and not declaring all their property rental income (and declaring it correctly), to HM Revenue & Customs.

“We may need to check clients are completing tax returns correctly, and that they have an accountant who is respectable and suitably qualified.”

Moreover, Mr Ioannou warns: “At what point does our responsibility and our potential liability start and stop?”

simoney.kyriakou@ft.com