Pensions Vs Buy to Let: A Comparison

Posted on: 4th May 2016 in Pensions

 As a UK expat in the UAE, can I even get a UK Buy-to-Let mortgage?

Customers here at Holborn Assets are often surprised that a UK BTL mortgage is even an option for them. That’s because there’s been a lot in the press about expat lenders pulling out of the market altogether – making it nigh impossible to get any deal, let alone a good BTL deal. In as far back as 2014, The National newspaper of the UAE reported that expat home buyers had been “cut adrift from UK property”, whilst Moneyfacts.co.uk confirms that the number of expat lenders shrunk from 19 in 2004 to 7 in 2014, with giant player Lloyds getting out of the game in 2012. But, says Jo Phillips, Head of Mortgages at Holborn Assets, this month, “we haven’t seen this shrink – as we use international lenders.” There remains plenty of choice for the savvy expat in the UAE looking to Buy-to-Let in the UK. “There is a myth,” says Philips, “that it is virtually impossible to get a mortgage if you live here. Let’s put that straight now. You can buy in the UK if you are an expat.”

But what about my pension pot?

Even if it turns out to be something the regulations let you do, is it worth raiding your pension pot to fund a UK BTL mortgage? Moneywise.co.uk says spending your retirement savings on a rental property “would be positively reckless.” Do you agree? Let’s have a look at the evidence: first with an overview of the pros and the cons of a UK Buy-To-Let mortgage – and then a closer look at whether it is worth plundering your pension pot to fund it.

The Pros of Buy-to-Let in the UK

As an expat in the UAE, UK Buy-to-Let is “doable”

However a UK BTL is funded, there are hoops to jump through for any UK expat in the UAE looking to arrange one. The route ahead is littered with truly exotic pitfalls. And a guide in the form of some independent expert advice is, in plain terms, a “no-brainer”. There will be administrative challenges, eligibility worries and unfamiliar fees. In this pressurising environment, you need somebody at your side who knows the game well enough to avoid the pitfalls and cut you a unique deal that fits what you can afford to pay back. And then there is the obvious fact that arranging a mortgage internationally is a pricey business, with lenders playing super-safe across all client arrangements. “Typically, lenders will offer Buy-to-Let mortgages for expats up to 75% of the purchase price,” says Philips of Holborn Assets. So that’s a minimum deposit of 25%. Expect a minimum loan size of £100,000. Interest rates currently start at 3.24% p.a.

A yield of just under 5% and £20k+ return per year on average

“The gross yield on a typical rental property in England and Wales is now 4.9% as of March 2016, compared to 5.1% in March 2015.” (BTL Index) So says LSL Property Services, the second-largest estate agency chain in the UK. UK broadsheet The Daily Telegraph adds that such a yield is “higher than the 3pc to 4pc yields you’d expect from a portfolio of blue chip shares or funds that invest in them.” Figures from LSL’s BTL Index show that average UK rents in March 2016 are 3% higher than this time last year – and also that rents have risen 15% in five years. The average BTL landlord has enjoyed a return of £22,135 over the last twelve months (with that return being calculated as the rental income plus any rise in the value of the property, but not taking into account any deductions like mortgage payments).

Bricks and mortar beat bits of paper

Here at Holborn Assets many of our mortgage clients report that it is the tangibility of having money in property that other financial products cannot match. A mortgaged property is an investment you can touch – unlike a pension, which is an agreement you can only read about. According to Kent Reliance, a third of 0ver-50s in the UK have already invested in rental property. And in a 2015 survey by Tilney BestInvest, 38% of respondents agreed that Buy-to-Let was an attractive long-term investment – 4% more than those seeing pensions favourably. Rational or irrational, the desire to own UK bricks and mortar for the purposes of letting can be arranged for you here in the UAE by a suitably-qualified broker. But, looking at the Cons rather than the Pros of BTL in the UK, are you sure you want to get involved?

The Cons of Buy-to-Let in the UK

It’s no wonder that Richard Lambert, Chief Executive of the National Landlords Association, was reported by the BBC as saying after the 2016 Spring Budget that “George Osborne is determined to bear down on the private rented sector.” Right now, there are ominous developments across four key areas of BTL taxation:

1. BTL mortgage tax relief – on the way out

UK broadsheet The Daily Telegraph called it the “Death of buy-to-let” when this mortgage tax relief legislation was announced in 2015. The BTL tax change is due to kick in next year and be fully in place by 2020. Although intended to level the playing field by targeting better-off BTL landlords, the move is set to drain the ability of all BTL landlords to offset their tax bill with relief from their mortgage interest payments. “Tax will be applied to the rent received,” explains The Telegraph, “rather than what is left of the rent after the mortgage interest has been paid.” Higher-rate taxpayers will no longer be able to claim mortgage interest relief at the rate they pay income tax – instead, by 2020, a flat-rate rate of 20% relief will apply to everybody. Which means better-off landlords will be hit worse. The modelling of Economics Professor Michael Ball of the University of Reading, UK, suggests that basic rate taxpayers will see a 10% fall in BTL returns – whilst higher rate taxpayers will be hit for between 30% and 40%. And that’s not the worst of it. There are fears that some BTL landlords will end up with tax bills exceeding their profits. Accountancy giants Smith and Williamson calculated last year that a BTL landlord paying a higher rate of tax will need to ensure that their mortgage interest does not exceed 75% of their rental income – or their BTL business will slide into the red. UK Chancellor Osborne’s legislation was supposed to address an “unfair” advantage to richer landlords built into the tax system. Until now, the BTL sector has been disproportionally easy for high-income individuals to do well in – and that’s because the higher the tax band you are on, the higher rate of tax relief you can claim on your BTL mortgage payments. But some say the biggest irony of the new tax measure is that the only landlords who come away unscathed are those with no mortgages to pay at all – who, being de facto the richest landlords in the sector, are the supposed targets of the legislation! Political ironies aside, what is certain is that this change to the taxation system makes BTL landlords more vulnerable to dips in rent and rises in interest rates. For the moment at least, the implications of this are not catastrophic: rents in the UK are unlikely to go much higher, but they are least typically expected to stay generally on the up. Interest rates are likewise anticipated to be stable for the time being, but with an upward momentum gathering slowly.

2. Stamp Duty hike of 3% just set in place

If you haven’t already bought a UK BTL property, you’ve just missed out on the chance to get it for 3% cheaper. As of April 1, 2016, 3% has been added to all tiers of Stamp Duty on BTL properties worth £40,000 and over – in the 14^th tweak to the UK Stamp Duty system since 1995.

	Before April 1, 2016	After April 1, 2016
£0-£39,999	0%	0%
£40,000-£125,000	0%	3%
£125,001-£250,000	2%	5%
£250,001-£925,000	5%	8%
£925,001-£1.5m	10%	13%
£1.5m	12%	15%

Stamp Duty is levied on the purchaser, so as a prospective BTL landlord, bad luck if you have just missed out. But there’s a silver lining. The 3% hike has sucked the demand out of the market. Buyers flocked to get their foot in the door before the April 1 deadline, with the result that now – as Jo Philips, Head of Mortgages at Holborn Assets, suggests – “less investors will be in the BTL market giving you the chance to either rent the property out quicker or command higher rental prices.” Also note that the above rate hike does not apply to anyone buying a first property, or selling their current home and buying a new one, regardless of what the property is used for.

3. BTL misses out on 8% slash to Capital Gains Tax

Dealing a third blow to BTL landlords is the fact that the shock 8% slash in Capital Gains Tax as from April 2016 will not apply to sales of second-home/Buy-to-Let property. As a basic rate taxpayer, you would pay 18% CGT on any profit made on the sale of your BTL property, or 28% if – as part of your tax assessment for the year – the profits of the BTL sale pushed your income into a higher tax bracket.

4. BTL misses out too on Inheritance Tax chop

BTL landlords also miss out on an upcoming revamp of Inheritance Tax (IHT). Going live in 2017 is Inheritance Tax legislation which will, according to the government, “reduce the burden of IHT for families by making it easier to pass on the family home to direct descendants …” As from April 6, 2017, UK homeowners will enjoy an extra £100,000 free from inheritance tax – provided the main family home is being passed to a direct descendant. And the value of this extra Nil-Rate Band will be rising year on year to hit £175,000 in 2020. But you’ve guessed it – BTL properties are not included in the new Nil-Rate Band structure. A fluid and hostile tax climate is the current reality of the UK BTL sector. But whether there is a perfect tax storm to be weathered right now or not, BTL – unlike pensions – is an active investment strategy where stress is to be expected.

BTL is an active investment; expect to put some hours in!

Expect to be up against it on many fronts! You have chosen to captain your own ship in exotic waters, so you must expect to weather frequent changes in conditions, tax-related and otherwise. And you must be ready to act. This Buy-to-Let business involves actually running a business, which means that tackling problems as you go is par for the course – unlike the business of simply buying off-the-shelf financial products and monitoring them when you feel like it. As Alan Higham from Fidelity points out, “an ISA doesn’t ring you at 2am to say the boiler is broken.” As an expat living in the UAE, you face the added inconvenience that your BTL property will be on the other side of the world. Maybe you would prefer to leave your pension pot intact and steer clear of hands-on financial products altogether.

So there are good reasons to leave my pension pot intact?

There are two excellent reasons to steer clear of a BTL mortgage if it means leaving your pension pot intact.

1. You will pay tax on taking out more than a quarter

You may or may not have a BTL purchase in mind. But either way, if you withdraw your pension fund in one go, then, as UK Financial Advisers Chase de Vere confirms, “you are likely to be hit with a hefty tax bill because after the first 25% tax-free lump sum, the remainder of the pension withdrawal will be taxed at your marginal rate of income tax.” If you do decide to fund a BTL enterprise with your pension, this means that the very act of beginning your active investment strategy will reduce your seed capital. Not a great start, for sure. With the average pension pot assessed by Retirement Advantage to be £35,000, you are looking at being 15% down before you even switch on your BTL revenue stream. “You would then,” suggest moneywise.co.uk, “be relying on rising house prices and a healthy yield to replace the money you’d have lost before you could even think about turning a profit.”

2. Don’t tamper with the tax-efficient wrapper!

Your pension is your gift to your future self. And whilst your hard-gotten gains are wrapped up in a pension, they enjoy a rosy tax climate you might not want to lose – especially given that the alternative may be the vicious tax squalls of the UK BTL sector. UK Government support for pensions is currently strong:

• For every £80 you put into a pension, the government will currently put in £20.
• Unlike a BTL investment, with pensions, you are not taxed on any gains you make. Taxation applies to pension withdrawals but not to income produced by the pension and then re-invested into it.
• Your pension can be passed on free of Inheritance Tax if you die before the age of 75; if you die over the age of 75, IHT is still not levied, but the recipient of the pension will pay income tax at their marginal rate on anything they take out of it.

Well? Shall I or shan’t I get a UK Buy-to-Let mortgage?

Other factors aside, pensions appear resoundingly more tax-efficient than Buy-to-Let investments. But the apparent resilience of pensions as investments is given its shine by the healthy-looking tax climate managed by the UK government. And pensions may simply not be in the sunshine forever. David Smith of bestinvest.com agrees that “whilst the status quo for pension tax relief remains, it is almost certain that it will change in the near future; tax relief on pension contributions is likely to be reduced or indeed withdrawn altogether.” In the BTL sector on the other hand, one thing has certainly recently changed for the better. And that is the level playing field introduced by the otherwise harsh mortgage relief legislation. If you enter the sector now as a low tax bracket BTL landlord, you’re not going to face the disadvantages faced by your predecessors. You won’t be competing against landlords who, because they have a higher marginal tax rate than you, are armed with an unfair advantage. In the future, landlords on a higher tax bracket than you will only be able to claim tax relief on their BTL mortgage payments at the same rate as you. Also on a positive note, BTL landlords have a variety of options to mitigate the mortgage relief legislation – including placing their property in a limited company – but the UK expat would be best advised to discuss the suitability of any of these strategies with a UAE broker. Generally, in choosing a BTL enterprise over a pension you might be accused of putting all your eggs in one basket. But you might not be putting your basket, at least, in a bad place in the long run. The Intermediary Mortgage Lenders Association (IMLA), “do not expect the tax increases aimed at buy-to-let investors to reverse the growth of the Private Rented Sector (PRS) or the buy-to-let mortgage market.” The bottom line is that prospects for the Private Rented Sector in the UK remain promising as long as the shortage in affordable housing continues. And the development of affordable housing involves political issues, so nothing is going to be magicked into existence overnight. Meanwhile, IMLA expects BTL lending in the UK to increase by over 11% between 2016 and 2017. Here at Holborn Assets we know that, as a UK expat in the UAE, arranging a Buy-to-Let mortgage in the UK is both possible and profitable given the right set of circumstances. And, just as surely, we recommend that the only way to see with any certainty whether those circumstances apply to you is by seeking independent financial advice. With so many factors involved, risking your pension – or even considering a separate BTL enterprise – is not something to be even considered without pro-active expert assistance.