Thanks to new pension freedom rules, many retirees have access for the first time to the capital they need for a property deposit. This change has sparked media speculation that there could be a surge in older buy-to-let investors wanting bricks and mortar to provide them with an ongoing retirement income.

Mortgage lenders have responded by preparing for an influx of new landlords, increasing the number of competitive mortgage deals on offer. Prospective buy-to-let landlords had a choice of 890 mortgages on 6 April 2015, when the new rules were implemented, compared with just 608 a year before, according to financial product comparison site Moneyfacts.

£900
How much it costs on average to evict a non-paying tenantBut should investors bite? And what do they need to consider when weighing up whether to become buy-to-let landlords?

A comparison site’s viewCharlotte Nelson, a spokesperson for Moneyfacts, emphasises that buy-to-let is a hugely attractive option for investors right now.

“The past few months have seen the number of buy-to-let deals soar. Not only this, they are cheaper too,” she says. “With low returns on savings accounts, it’s no surprise that buy-to-let has definitely seen a boost. Newly emancipated pensioners are genuinely considering buy-to-let as a retirement option.”

Like many others, however, Nelson warns against rushing in. She urges potential investors to do their homework thoroughly to assess the risks involved before committing their retirement savings to such a large and illiquid investment.
"These deals are often accompanied by hefty fees"
One of those risks relates to the Bank of England (BoE) base rate of interest. Although the rate has been at a record low of 0.5% for more than six years, the BoE’s Governor, Mark Carney, has indicated that UK interest rates could start rising “at the turn of the year”, with the base rate gradually increasing over the following three years to about 2%. And despite concerns that the Government might revise its plans on the back of recent market volatility in Asia, the interest rate rise is still on the cards.

Banks and building societies will normally lend 80% of a buy-to-let property’s price, and mortgages are usually arranged so that the rent covers the monthly payment with a margin to spare. But an investor thinking of buying now or remortgaging might want to take out a fixed-rate loan to ensure the payments remain affordable.

“Borrowers will have a large choice of mortgage deals, with many of the options being the lowest we have ever seen,” says Nelson. “However, these deals are often accompanied by hefty fees, which can add significantly to the overall cost of the mortgage.” 

Potential investors, she adds, should try not to be fooled by the low headline rate and “assess the true cost of the mortgage instead”.

Those who intend to use buy-to-let as a source of income throughout their retirement should also be aware of maximum age limits on mortgages. Most lenders write into the terms and conditions of a buy-to-let mortgage that borrowers must repay their loans in full by the age of 70 or 75. Nationwide Building Society is unusual in allowing buy-to-let landlords to keep their mortgages until a maximum age of 105.

Chancellor George Osborne announced in the 2015 Summer Budget that tax relief for buy-to-let mortgage payments would be limited to the basic income tax rate of 20%. Higher earners who pay 40% or more will pay more tax on their rental income as a result.

The estate agent’s view One look at property rental prices can cause a would-be buy-to-let landlord’s eyes to light up.

The average landlord in England and Wales has seen a return of £16,216 in absolute terms, before deductions such as mortgage payments and maintenance. Of this, the average capital gain has contributed £7,946 – but landlords should regard this as a bonus rather than a guaranteed part of the total return. Property prices are linked to the economy and are sensitive to tax policies, and therefore can go down as well as up.

For now, though, resilient yields backed up by rapid rent rises are a boon for landlords, says Adrian Gill, Director of estate agents Reeds Rains and Your Move. “Growing wage packets and a strengthening economy mean that a greater number of tenants are able to afford higher rents,” he explains. “With such an overall shortage of housing in the UK, rental costs are primarily driven by the amount tenants are capable of paying.”

But reaping sizable dividends on a buy-to-let property each month is not as straightforward as it might first appear to would-be landlords.

Rents rose by 5.6% during the year to the end of June 2015, according to research by Reed Rains and Your Move. However, these rises were accompanied by a 4.5% increase in property prices (the research uses data relating to typical buy-to-let properties).

This means that the gross rental yield (annual rent divided by the purchase price of property, multiplied by 100) on a typical property in England and Wales remained steady in June 2015 at 5.1% – the same as it was in June 2014.

And while the buy-to-let landlords might not have seen greater yields as a result of rising rents, tenants still had more to pay in rent each month. The rise in rents was accompanied by an increase in rent arrears – 8.7% of all rent payable in June 2015, compared with 7.8% in June 2014.

Evicting a non-paying tenant can be a lengthy and expensive business. While there are different routes that can be taken to evict a tenant, courts expect landlords to follow procedures precisely. Members of the National Landlords Association reported that it takes an average of four months and £900 to bring a tenancy to an end – this is just for court and legal fees and does not include the loss of rental income.

Landlords also need to budget for ‘voids’ – periods when their property is unoccupied and not earning. However, a quarterly survey produced by the lender Paragon Mortgages showed that the average void period experienced by UK landlords fell to 2.6 weeks in the last quarter of 2014, and has not risen beyond 3.5 weeks during the past 13 years.

The investment adviser’s view Despite early speculation, it seems investors are being more cautious than expected about spending their hard-earned savings on buy-to-let property.

Richard Parkin, Head of Retirement at Fidelity Worldwide Investment, says: “Retirement monies flowing into buy-to-let have received a lot of traction in the press. But, while our experience is very anecdotal, we would say that the aspirations of retirees are actually a little more modest.

“Of those who want to put money into property, a number are keen to purchase holiday homes for their own use or want to help their children buy a property. Only two or three callers have declared that they are seriously looking into buy-to-let, which does not suggest a boom from our point of view.”

The general consensus It is clear that buy-to-let can prove a highly profitable venture, but like all investments, both income earned and capital returns can fluctuate (and since the original version of this feature was published, rents across England and Wales have fallen on a monthly basis for the first time since March 2015). Unlike most other investments, however, owning and running a buy-to-let property can prove very hard work, even if the property is managed by an agent.

For the time being, at least, it seems that many of those entering retirement are mindful of the potential problems as well as the profits – and carefully considering the pros and cons of buy-to-let before taking the plunge.


A taxing decision Taking out a deposit on a buy-to-let property could push investors into a higher tax bracket

Pension investors are accustomed to the idea that they can withdraw 25% of their funds as tax-free cash. So it may come as quite a shock that they could end up paying the 40% or 45% rate of income tax on part of their withdrawal if they decide to take out significantly more than the 25%.

Any withdrawals an investor makes after taking the 25% tax-free lump sum will be included in their annual earnings for income tax purposes. Anyone withdrawing enough to put down a deposit could be pushed into the 40% tax bracket, at the very least. And people could be drawing a pension to live on as well as buy a property, which could easily push them up a tax band, even if they are investing in a small ‘two-up, two-down’ house in an area where property prices are relatively low.

Those whose pension withdrawals take their total annual earnings over £100,000 will also start to lose their tax-free personal allowance. If their earnings plus pension withdrawals exceed £150,000, they will pay 45% on the top slice.

In addition, because a one-off cash withdrawal will initially be treated by HM Revenue & Customs (HMRC) as though it is a monthly event, an investor could face paying an emergency tax rate that is far higher than the amount they should be paying.

Investors must fill in a form to reclaim the overpayment within a few weeks, or wait until the end of the tax year when HMRC will adjust the tax due to correct the situation.


The original version of this article was published in the September 2015 print edition of the Review.