The new government plans to increase capital gains tax (known as CGT) to as much as 40% or 50%. This is a tax that is charged on the profit (or capital gain) that is recorded from buying and selling assets such as houses or shares. The reason for the increase is clear enough. At its current level of 18% there is a huge incentive for people to try to change income, which is taxed at the normal income tax rate, into capital gains.

In fact, every buy to let investor that uses an interest-only mortgage to minimise income tax is taking advantage of the difference in these two rates of tax because it reduces the amount of tax paid on monthly rental because most of it goes to paying interest on the mortgage. The fact that one could do this and wait for houses to increase in value, with most of that profit being taxed at the lower rate, was a major attraction for many higher-rate tax payers to invest in residential housing.

The bigger worry for the government was not really BTL investors, but those in business and areas such as private equity funds because most of the payment that goes to these people is calculated on capital gains. So in many ways moving to equalize the tax between the two is fairer.

But the new tax could be unfair in one very important respect and that is when it comes to inflation. If property prices rise in line with inflation their owners aren’t actually becoming any richer. Yet they will have to pay a tax of 40% or 50% no that increase in value.

How to protect your Buy to Let Portfolio from CGT

Investors need to quickly take stock of their current portfolio and assess how vulnerable it is to a rise in capital gains tax. If you are an investor who has been relying primarily on rising property values to provide the majority of your income and return then you should reconsider your portfolio with an eye to earning ongoing rental yield from it. If you have several properties that you have owned for many years and that have increased in value considerably, accumulating capital gains all this time, then you may need to sell one or more of them so that your profits are taxed at the current lower rate. You can then reinvest the proceeds in new properties with current market values, which essential sets the clock to zero on the gains.

If you are a couple and are buying properties you should also consider the fact that British tax law treats both partners separately. So it makes sense to ensure that both are able to take full advantage of tax-free income allowances in each tax year. This is also important if you have several properties as there is also an annual capital gains tax allowance before which you have to start paying tax, so it may be more efficient to stagger the sale of properties over several years to save on tax.

What are the advantages of managing agents for buy to let?

The biggest advantage is that it takes away much of the stress involved. A letting agent will have the job of finding tenants and ensuring that they are high quality. That will often mean checking their credit score and telephoning their references such as an employer and previous landlord. You could do these tenant checks yourself but many people don’t so it probably makes sense to pay to be sure it gets done rather than not done. Many letting agents will also offer rental guarantees as part of their service. This means that if the tenants turn out to be bad apples and don’t pay their rent, the insurance policy will kick in and cover legal costs and compensation for their rent until they have been evicted and sometimes even until new tenants have been found. The other big advantage is that they will have to deal with calls late at night if there are problems. They will often have a list of reliable tradesmen such as plumbers and electricians on hand to deal with these faults.

In many cases the quality of the work that is done will be higher than if you hired an electrician or plumber yourself. Simply put, an electrician who gets tens or even hundreds of jobs a year from a single managing agent will work hard to keep the agent happy. He will arrive on time, do the work promptly and do it properly. On the other hand, if he (or she) thinks that they will just get a single job from you to fix one problem then they may well arrive late, keep you waiting and take their time doing the job. If you think about all the times you’ve ever called a plumber who didn’t arrive. The odds are that he was working on a more important job for a managing agent so left you out to dry.

What are the disadvantages?

The biggest disadvantage is cost. Many managing agents will charge a fee of about 4% to 6% of the annual rent to look after the property for you. If you have a big mortgage this can leave you somewhat stretched, especially since the typical fee to find a tenant is about 8 percent of the annual rent. That means you could be paying as much as 15 percent of your gross income in fees before you’ve even dealt with your other major costs such as servicing your mortgage. Your maintenance costs will also be much lower if you are handy with a hammer and paintbrush and do much of the work yourself. That said, if you are calling in tradesmen to do the work for you then you may well end up paying more yourself for the job than you would if it was through a managing agent for the reasons I outlines above.

Some people may also feel a loss of control in using an agent. If you are very hands on and want to meet your tenants yourself before agreeing to anything then you should probably stay with your instincts and remain hands on. Either way you probably still want to ensure you minimise some of the risks by ensuring that you have proper landlords insurance and rental guarantee cover. Buy to let investing is uncertain enough as it is without you having to increase the risk that you take on. Using a managing agent can help you reduce some of the uncertainty, but it is certainly not the only way.

Do your homework

All investing is risky. Don’t let anyone tell you otherwise. And the same is true for buy to let investing. In fact, even though many people look at buy to let as a safer form of investment than, say, buying shares or putting money into an insurance policy, there are some ways in which buy to let is far riskier. If you were to invest in a diversified portfolio of shares and bonds then you have little reason to worry about any one of them going bust. Most big funds or ETFs will invest in a basket of at least 50 companies. There is always the risk that one of them will be the next Enron with a crook in charge, but even if it is you will have lost no more than 1/50 (or 2%) of your investment. Now you clearly don’t want that to happen, but if it were to happen you  would not be financially wiped out.

The big difference with buy to let investing is that unless you have a huge empire of properties then you will end up putting a very large portion of your wealth into one basket. If you owned just one or two properties, as most small landlords do, and one was to run into trouble then you really could see yourself wipe out.

These risks also have their rewards. And if bought at the right time and in the right place, the returns that can be earned from property can be higher than from shares in the market. That said you need to be aware of the risks and need to take what steps you can to mitigate them.

One of the biggest risks you will face is that your tenants won’t pay their rent on time, if at all. A couple of months of missed payments can cause serious financial harm, especially if you have a mortgage on the property that has to be paid every month. There are a couple of steps you can take. The first is to check your tenants carefully. If you have hired a letting agent, then you should ensure that they do this as part of their service. You can also double check yourself. The National Landlords’ Association (NLA) offers a cheap tenant check service to its members that costs just £8 (non-members can get it for £12). This will include checks on their identity, whether there are any court judgements against them and whether they have filed for bankruptcy or insolvency. It doesn’t cost much and gives some peace of mind.

A more comprehensive test can also be done that  costs £23 (£28 for non-members) that will also include references from their employers and previous landlords or letting agents. It is a simple step that can be done online so that at least you have a better chance of weeding out the real no-hope tenants.

You also want to be sure you have proper landlords insurance cover over the property. This needs to cover your liability (if a tenant was to be hurt, for instance, through some fault of your own) as well as damage that tenants might cause. You don’t want to be caught short here.

Beyond that you might want to consider rental insurance or rent guarantees as well as legal expenses insurance that will cover your costs and lost income if a tenant stops paying rent and has to be evicted. This process can take a couple of months and run up large legal bills, so you really want to have at least a minimum level of cover. If you have a large portfolio of properties, say 10 or more, then you can opt to give this a miss and rely instead on self-insurance. After all, with 10 properties the odds are slim that tenants will be defaulting on their rent in more than 1 property at a time. So you can probably take a chance knowing you can still keep up with mortgage payments from the other properties. But for a small landlord, tenant checks and some forms of landlord insurance are essential to reducing the risks in buy to let investments.

How much do Tenancy Deposit Protection Schemes Cost?

The cost for these plans ranges from free for the Deposit Protection Service (which uses interest on the money it holds to fund itself)    to almost £90 pounds (including joining fee) for My Deposits.co.uk, an insurance-based scheme where the landlord keeps the deposit. If you are just a small landlord holding just one or two deposits then it would probably be worth your while to go for the free safekeeping plan since you would not be losing much interest anyway. The insurance schemes are much better suited to letting agents and landlords with larger portfolios over which they can spread the fixed costs of an insurance plan, which usually has a high joining fee because the insurance company needs to run credit checks.
One can also get discounts on some plans through membership of landlords associations such as the National Landlord’s Association, which owns part of MyDeposits.co.uk.

What other requirements are there?

Landlords also have some other responsibilities and should be sure to follow the rules. The main one is that within two weeks of receiving a deposit they have to write to the tenant explaining exactly where the deposit is held. The also have to give details of the protection scheme they have selected, contact details and information about what tenants can do in the case of a dispute.

What is changing?

Later this year the government will be changing the laws affecting letting agreements where the rent is between £25,000 and £100,000 a year. Once that happens tenant deposits within this new bracket will also have to be protected.

By many indications the market is still falling sharply. Take the case of Fergus Wilson and his wife Judith, two British maths teachers who between them built a staggering empire of buy-to-let homes with more than 700 properties in their portfolio. Little wonder then that they were dubbed the king and queen of buy to let by the British press. Yet this massive investment portfolio, which at one point reached 900 properties and was worth more than 225 million pounds to them net of debt, has come under enormous pressure in the downturn. Last year tenants in almost 100 of the properties were missing rental payments. Many had lost their jobs. Banks were threatening to take back the properties. Now the whole portfolio is in a sort of managed run-down with the Wilson’s trying to sell what they can without dumping properties. Provided markets hold up they may be able to salvage something. But their experience should be a warning to new investors. The fact that such experienced investors with such a diverse portfolio and with significant capital are experiencing difficulties does not auger well for the state of the market. Especially since the Wilson’s invested in sections of the market, mainly small family-sized buy-to-let houses, that were thought to be far more stable than some such as city-centre flats. The first lesson of their experience is that unless you have deep pockets and the ability to ride out a downturn and significant period of negative equity then now may be a risky time to invest indeed

The second lesson is that the Wilson’s first started building their empire in the early 1990s when Britain was suffering a previous and deep property downturn. Mr Wilson initially started buying houses at deep discounts on auction during that downturn. He was then able to immediately lever them up by getting them valued for more than he had paid and getting 100% mortgages over the properties. Interest payments were then entirely made using income from renting them out. In fact he didn’t put any of his own money in since he had 28 days after the completion of the auction to line up financing. It is an amazing tale of an empire that pulled itself up by its own bootstraps. Yet the second lesson here is about timing. One would think that Mr Wilson knows a thing or two about property downturns, having started to make his fortune buying houses during a particularly deep one. If he is now selling it probably suggests that he thinks prices may well fall further.

That’s the bit about blood in the street. The bit about why the buy-to-let cycle may be turning up is found in recent indications that rents are increasing, which would lead to improved rental yields for buy to let properties. The latest survey released in mid March 2010 by the Royal Institute of Chartered Surveyors (RICS) showed that the supply of new rental properties coming onto the market has slowed for a second quarter in a row and that rents seem to have stopped falling for the first time in more than a year and a half. Many of them now expect rents to start rising. This suggests that many unwilling landlords who put their properties out to rent because they didn’t want to sell into a falling market are taking advantage of the recent blip in property prices to sell. This is a positive development but it is not unmitigated good news for landlords. This is because property prices have picked up so that rental yields in many areas still look unattractive.

The recovery in housing prices also looks dangerously fragile with the real prospect of a big dip in house prices coming as soon as the Bank of England starts to increase interest rates.  There may be plenty of buy-to-let blood on the streets, but perhaps not enough to get people to start buying.

The plan has provoked a storm of criticism from landlords. The Residential Landlord’s Association worries that the move is bad for landlords and for tenants. It says that “Nurses, teachers and a generation of young workers could be hit by a government plan to prohibit areas of shared housing for groups of unrelated tenants” and is calling on landlords to lobby their local political representatives.
The situation may yet change but until there is greater clarity it may be sensible to avoid making any investment decisions relating to student buy to let before April.

Property investors looking to get higher rental yields than they would get from most buy to let properties, they should consider targeting the market for student lets. Rents for students have generally been rising over the past few years thanks to good demand. And because many investors have been wary of going into this market, rental yields are pretty good in comparison with family houses.

Why consider student lets?

The first reason to look at letting to students is simply down to demand. The government’s policy over the past years has been to try to increase the number of students attending universities. With the economy in a downturn, a lot of young people are taking up studies or extending their studies to try to make themselves more attractive to employers. In many cases, with no jobs out there anyway, it makes little sense for them not to be studying. Enrolment for the 2010 year is expected to be up significantly with applications running about 12% above last year’s rate. That could lead to a shortage of student flats and other accommodation in some university towns.

Rising rents

Whereas rents in most parts of the market have stagnated or even fallen over the past two years, rents for student lets have kept on rising. Knight Frank, a property company, reckons they have increased every year on average by 5% a year over the past five years.

High occupancy

Occupancies in some student towns have also been really high. Estate agents reckon that there has been 100% occupancy in some instances

High yields

Rental yields on student accommodation also run somewhat higher than on family homes. Research by Knight Frank shows that yields on the highest quality student accommodation are about 6.5% to 7% in regional towns and about 0.5 percentage points below that in London. This is for prime accommodation. Obviously going down the price and quality scale a bit will result in somewhat higher yields. In comparison when one looks at average residential housing buy to let yields in London, these are currently averaging about 5.5% to 6% at the moment.  On houses and flats for families the range of gross yields runs to as high as 7% on some properties and it falls to below 4% in some of the most sought after areas with more expensive houses.

Remember that in some key university towns where the supply of housing is much tighter yields are quite a bit higher and landlords are achieving annual rental increases of a bit more than 5% a year. Many landlords automatically turn up their noses at students. Who, after all, wants a bunch of slobs smoking dope and throwing wild parties, but in fact this is a market well worth considering for improved rental yields on buy to let property investments.

What makes landlords property insurance different?

The key difference between normal household or structural insurance and buy to let insurance is that the insurer knows that it is taking on a slightly higher risk profile but it prepared for that. The odds are that you will end up paying at least 25% more for landlord’s insurance than you would for household cover. But that cost ensures that your insurance company won’t turn around and repudiate a claim because the property is being let.
Landlord insurance will also pay out for other sorts of loss compared. Say a pipe busts and damages everything in the house so that it needs months to be repaired. During that time you won’t be getting any income from the property but still have to keep paying the mortgage. A good policy will pay out the rent that you would have received.

Some of the other elements that a comprehensive buy to let insurance policy will include are:

Legal expenses

If you have to evict tenants because they have stopped paying rent  then the legal bills can quickly add up. Don’t forget that lawyers charge by the hour. If you have legal cover then all of these costs will also be covered.

Rent guarantee

This is usually an optional add-on or can be bought separately as a stand-alone policy. The basic idea here is that you get a proper credit check and references check of your prospective tenants. If they pass the credit checks you can then buy rent guarantee insurance that covers you against them suddenly stopping paying rent. If, for whatever reason they don’t pay, then the insurance policy will kick in and start paying legal costs to get them out of your property while still covering the rent that they would have been paying. This comes in different levels with some also guaranteeing rent if the property stands empty for a period of time while you find a new tenant.

Landlords liability insurance

This is perhaps one of the most important bits of cover. Say through no fault of your own a wall falls down and badly injures a tenant. This was an accident that you couldn’t have foreseen but you may still end up facing long and expensive lawsuits with the possibility of having to pay millions in damages. Proper liability cover should be included in your landlords building insurance to protect you.

Landlord contents insurance

If you provide a furnished property, or even just provide a minimum level of furnishing such as a fridge, dishwasher, washing machine and the like then you may want to also consider contents insurance to cover theft or damage to these items

Boiler insurance

Depending on how hands on you are prepared to be as a landlord will determine whether you also want to take out additional cover such as boiler insurance cover and central heating insurance. These are often quite pricy but can provide peace of mind in the even that a boiler suddenly stops working in the middle of winter or that the central heating springs a leak. If you are happy to take calls in the middle of the night and run around arranging plumbers and gas engineers then you may decide it is not worth it. But if you are out of the country or not especially technically minded then boiler insurance and central heating insurance will mean that the tenants get a dedicated number to call and you don’t have to worry about fixing the problem yourself.

It may be tempting to go for the first cheap landlord insurance policy you get, but finding good buy to let insurance cover means shopping around a bit. Try to get landlord insurance quotes from a few different providers as the premiums they charge can vary considerably. When I last bought buy to let home insurance cover some landlord insurance quotes were easily double the one that I eventually accepted for more or less the same level of cover. So be sure to shop around and get all your options explained to you. Also be sure that you discuss all the issues with your insurer. Failure to disclose problems such as a history of subsidence or previous flooding could result in an insurance claim being rejected.