Tax changes start to bite for property investors

Residential landlords have faced challenging conditions since April 2017, facing a higher tax burden due to changes in how they declare their rental income.

Prior to this change, landlords would only pay income tax on their rental income net of mortgage interest and other expenses incurred on the property.

With most property investors using interest-only mortgages, this meant that it was possible for many landlords to deduct all of their mortgage costs from taxable rental income.

New research shows that landlords with between 6 and 20 properties in their portfolios have increased their market share from 35% to 39%.

It follows a fall at the end of last year in the proportion of landlords with 3 to 5 properties in their portfolios. The proportion fell from 26% to 24%, as part of a growing polarisation between smaller scale landlords and those with larger property portfolios.

There was also a change at the top end, with landlords who own more than 50 properties falling from 6% to 4%. The average property portfolio size fell from 13.1 to 11.6 properties.

The findings form part of Paragon’s latest PRS Trends research and are based on interviews with more than 200 experienced landlords in the first quarter of the year.

Resizing a property portfolio seems to be one of a number of tactics being used by landlords who are adapting to tax and economic changes in the buy-to-let investment sector. Other factors playing an important role are reductions in property gearing and rent increases.

Paragon found that average property gearing, measuring the loan to value ratio of an overall property portfolio, fell from 35% to 32% compared with three months earlier. Gearing fell from a peak of 43% back in 2012, now at its lowest level since Paragon’s PRS Trends survey began in 2001.

Another key finding from the survey was almost a quarter of landlords reporting rent increases in the past quarter.

Landlords reported spending more of their rental income on mortgage costs, rising to 30% of income in this quarter, from 26% at the end of 2017.

John Heron, Managing Director of Mortgages at Paragon said:

“Our latest survey demonstrates how tax and regulatory changes are beginning to drive changes in landlord behaviour, with evidence of polarisation between small landlords and those with more substantial portfolios beginning to emerge.

“Our own experience highlights that landlords with larger portfolios need access to products that cater for landlords with more complex requirements and broader underwriting expertise, increasing the role for specialist lenders in the buy-to-let market.”

With the tax burden on landlords continuing to rise through until April 2020, it’s important for property investors to consider the structure of their portfolio, gearing levels and how much rent they charge.

In the 2019/20 tax year, it will only be possible to claim 25% of mortgage tax relief, reducing to zero for 2020/21 at which point all rental income will become taxable.

However, from 2020/21 landlords will get a 20% tax credit on their mortgage interest, which means they can effectively cut their tax bill on rental income by 20% of the mortgage interest paid.