How much can you make from a buy-to-let property?
Buy-to-let investment has mushroomed over recent years with the high demand for rental property and changes to pension rules fuelling the rise in popularity. Many see property investment as a route to riches with ever increasing house prices and rents providing a steady income and capital appreciation from their investment.
If you are considering purchasing a buy-to-let property then you need to understand the costs involved and the likely return on your investment, together with the risks involved. In this article I aim to answer these questions and hopefully give a clear idea of how much you can make from a buy-to-let investment?
I have decided to use a case study to illustrate the returns that can be achieved from a buy-to-let investment, the details of which are as follows:
Purchase price - £150,000
Deposit - £30,000
Mortgage - £120,000 2yr fixed rate @ 2.99%, monthly payment £299 (Clydesdale Bank - 2 year fixed deal - found using our best buy mortgage comparison table provided by Habito)
The income that you can expect from your buy-to-let investment will vary depending on the type of property you buy and the area in which you buy. In May 2019 UK rental yields were an average of 4.29% (LSL Property Services plc Buy-to-Let Index), the regional yields varied from a low of 3.18% in London to a high of 5.0% in the North East.
For the purposes of my case study I am going to use an annual rental yield of 5.0% which means the rental income from my case study property will be £7,500 per annum.
Rental income from buy-to-let investments is liable to income tax but I will deal with taxation in a later section.
'One off' Mortgage and purchase costsly payments
Mortgage fees - £2,234 (Clydesdale Bank 2 year fixed rate deal)
Survey fee - £500
Stamp Duty - £4,500 (second home surcharge at 3% on £150,000 purchase price)
Legal fees - £700
Mortgage repayments - £3,588 p.a (299 p.m)
Loss of interest received on £30,000 deposit @ 1% per annum - £240 p.a. (net of 20% income tax)
Letting agent fees (approx. 12% of rental income) - £900 p.a. (no change but originally shown as a monthly amount)
Landlord & rental insurance - £960 p.a. (no change but originally shown as a monthly amount)
Estimated repairs - £500 p.a.
Estimated void period rental loss - £500 p.a.
Total monthly mortgage/other costs - £6,684 p.m.
Additional mortgage setup costs - £7,734
Annual rental yield
Annual rental yield (C) is calculated by taking the annual rental income less annual costs (A) and dividing it by the purchase price of the property plus related costs (B).
A - Net rental income = £7,500 - £6,684 = £816 p.a.
B - Total cost of purchasing property = £150,000 + £7,734 = £157,734
C - Annual rental yield = 0.5%
Over the past 10 years (2005 - 2020) the average house price in the UK has increased by around 35%. If I assume that house price increases will move in line with the last 10 years then our case study property will increase in value from £150,000 in 2020 to £202,500 in 2030. This is equivalent to an annual capital growth of 3.5%.
Proceeds from all buy-to-let investments are subject to taxation. Rental income (less some allowances) is subject to Income Tax at the individual's marginal rate. As from 6th April 2020 tax relief for mortgage costs will be restricted to the basic rate of income tax, currently 20% and will be treated as a reduction in tax liability rather than a reduction in taxable rental income. Buy-to-let properties are also subject to capital gains tax (CGT). This is charged at a rate of 28% (for higher-rate taxpayers) or 18% (basic-rate taxpayers) on any growth in the value of the property.
If you're a basic rate taxpayer, bear in mind that the gain will be added to your income, so this could push you into a higher-rate band. Everyone has a tax-free capital gains allowance of £12,300 per year in 2020-21, so you'll only need to pay CGT on profits above this threshold. It's also possible to offset some costs, such as what you paid out for stamp duty and conveyancing when you bought the property and any charges associated with selling it (including estate agent fees). You should also be able to offset any capital improvements you've made to the property against your CGT bill. You're not allowed to deduct outgoings on the upkeep of the property or mortgage interest.
How can I make from a buy-to-let investment - summary
In the case study above the total return in the first year would be:
- 0.5% in rental yield
- 3.5% in capital growth
This equates to 3.5% gross total return on the investment before taxation. Bear in mind that you won't enjoy the capital growth until you actually sell the property.
As you can see from the case study if you experience high repair costs or long void periods your investment could be costing you money on a monthly basis. There are also upfront mortgage cost of £7,734 which in our cases study would wipe out the first 12 months rental income.
The conclusion is that if you are investing in buy-to-let financed via a mortgage then monthly net rental income is likely to negligible at best. You would the be relying on capital growth to achieve a return on your investment. However a buy-to-let investment without the need for a mortgage can provide both a monthly income and capital growth over time.
- The above calculations assume that a 30% deposit is available and the balance of the purchase price is secured with a mortgage
- All costs are estimates and a may be lower or higher
- House price growth figures are for the whole of the UK and may be lower or higher in specific locations
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