Safe as Houses
Andrea Solana of MASECO Private Wealth examines the financial considerations when looking at investment in property
Historically, property alongside pensions has been one of the most common ways to invest in the UK. As many know, property is an asset class, just like cash, bonds and shares and can serve as a form of diversification when building an investment portfolio. In the UK, there have traditionally been many tax incentives for property investing. However, these are slowly being tapered back making other avenues of investing potentially more attractive.
Why has investing in UK property been attractive?
The UK does not currently charge capital gains tax on the sale of a main residence (as opposed to the US $250,000 capital gain allowance for qualifying main residences). As property prices have increased over the years, it has allowed individuals to upgrade and downsize their properties and keep their gains in tact, without the extra consideration of what might be payable to HMRC.
In addition to tax advantages provided for a main residence, the UK also historically allowed for attractive benefits related to buy-to-let properties. Landlords with buy-to-let properties have been able to generate considerable rental income and that income could be offset against mortgage interest and other 'wear and tear' allowances leaving a very tax efficient way to place capital to work.
What has changed?
Since April 2016, second properties attract an additional 3% Stamp Duty Land Tax (SDLT) charge on purchase. On sale, gains tax is charged at 18% or 28% as opposed to a more favorable gains tax of 10% or 20% for the sale of other investments such as shares. Additionally, between this tax year and 2020, mortgage interest relief is gradually being capped at a 20% basic rate of tax benefit and gross rental income will be used to determine the tax rate applicable on the net rental income earned each year. With some of the incentives being tapered back, many people are reconsidering the extent to which property sits within their overall investment portfolio.
What can property offer investors?
As noted above, property is an asset class separate and distinct from fixed income and equities. Therefore, it can serve as a diversifier within an individual's overall investment portfolio.
When you own property, there are two main ways to earn a return:
(1) Make the property a buy-to-let and earn an income stream over time by letting it out to tenants.
(2) Hold the property for use as a main residence or second home and sell the property at a later date for a higher price than you purchased it for.
For some approaching retirement, a buy-to-let property may, depending on individual circumstances, offer an income stream to supplement pension income and possibly serve as a form of annuity over time.
What are the risks of investing in property?
It may not seem like it from recent history but it is important to remember that property prices and demand for rentals can ebb and flow over time. Additionally, property is considered to be a more illiquid investment as you cannot get your money out immediately if you need quick access to capital. It is important to factor in any buying, selling, maintenance and management costs associated with owning a property as these are not insignificant. Additionally, this not only involves financial costs but also a time cost. When there is a mortgage loan in place, you need to factor in that there is no guarantee that the rental income will fully cover the loan repayment over time. And, if you cannot keep up with the loan repayments, the bank can reclaim the property. This is why it is important to remember that investment in property should be a long-term buying decision and time horizon and access to other more liquid sources of capital should be carefully considered before purchase. If the housing market slows down, having the ability to postpone a sale until more favorable market conditions return will certainly help increase the odds of a profitable investment.
As an American living in the UK, almost nothing related to your financial affairs is easy. The consequences of seemingly simple decisions – such as how to pay for a new home or purchase a mutual fund - may create unnecessary tax charges and complexities. There are a number of key milestones that occur, from the time you arrive in the UK to the time you potentially approach and eventually reach retirement. Many of these changes will impact the appropriate wealth management strategies for American expats. Understanding how rules will change for you over time will allow you to plan ahead and make prudent financial decisions.
If you would like a full copy of MASECO's '39 Steps to Smart Living in the UK', visit www.masecoprivatewealth.com/the39steps or contact firstname.lastname@example.org. MASECO LLP trading as MASECO Private Wealth is authorised and regulated by the Financial Conduct Authority, the Financial Conduct Authority does not regulate tax advice. MASECO Private Wealth is not a tax specialist. We strongly recommend that every client seeks their own tax advice prior to acting on any of the strategies described in this article.