Time to invest in buy-to-let Britain?

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After years in the doldrums, buy-to-let is again being hailed as a key tool for investors, against a backdrop of miserable savings rates and uncertainty over pensions.

Rising rents are tempting thousands of savers to invest in rental properties and who can blame them? The average easy access savings account now pays an average of 0.78 per cent. In comparison, rental income is rising on the back of strong demand from would-be buyers struggling to raise big enough deposits to buy their own homes.

Click to see map of buy-to-let yields in England and Wales by local authority

The average rent in England and Wales rose 3.3 per cent over the past year, according to the LSL Buy-to-let Index.

An analysis by Savills for FT Money (see map) shows that investors can find yields ranging from 5.4 per cent in Brighton & Hove to 6.8 per cent in Nottingham and more than 7 per cent in London.

However investors looking to buy in London should be aware that yields vary significantly, says Lucian Cook, residential research director at Savills.

“Gross yields are around 4 per cent in prime markets such as City of Westminster and Kensington & Chelsea, increasing to 5 per cent in Wandsworth, 5.5 per cent in Brent, 6 per cent in Redbridge and exceeding 7 per cent in Barking and Dagenham,” says Cook.

For those considering buying a property to let in prime central London, it is worth considering which type of property will let best and the yields on offer.

According to Lucy Morton, head of lettings at WA Ellis, yields have fallen in recent months to about 3.6 per cent. She says she has seen more landlords selling their properties because rents have not kept up with the strong capital growth.

“One or two-bedroom flats are still a safe bet and will typically let within one week,” she says.

Figures from Savills support this. Rental values for one-bed properties have risen 1.2 per cent over the past year, compared to a 1.5 per cent decline for properties with four bedrooms.

Professional landlords can often achieve higher yields by investing in specialist areas of the market, says David Whittaker of Mortgages for Business, a buy-to-let broker. Houses in Multiple Occupation offer average annual gross yields of 10.5 per cent, while semi-commercial property has average yields of 8.2 per cent.

The yields on offer have already attracted more investors to the buy-to-let market. Figures from the Council of Mortgage Lenders, the trade body for lenders, show that the number of new buy-to-let mortgages advanced reached its highest level in four years in 2012.

A total of 136,900 loans were agreed during 2012, up from 121,500 in 2011. Nearly half of these were for landlords remortgaging their existing property.

However, experts say investors need to do their research carefully before buying a property to let as they are effectively starting a small business.

Despite the benefits, becoming a landlord is not a one-way bet. There have been signs that more landlords are struggling to meet their mortgage repayments. The repossession rate – the total of repossessions in relation to the number of mortgages – has reached 0.24 per cent for the first time in the buy-to-let market.

“The knowledge and skills needed to be a landlord are considerable and it is important for anyone considering a move into the buy-to-let market to be well aware of the law and their responsibilities to tenants,” says Chris Norris, head of policy at the National Landlords Association.

Investors should also consider the various costs involved with managing a property, such as mortgage costs, insurance, maintenance and checks, tax and void periods.

“To work out if a particular property will generate sufficient income to cover all the costs the investor needs to look at the annual net yield, for example, annual rental income minus costs,” explains Whittaker.

Mortgage rates for landlords are improving but the deposit requirements remain high. For this reason, many younger investors tend to struggle to raise the necessary deposits to make a purchase.

Most lenders require at least a 25 per cent deposit, although the best rates are limited to landlords with deposits – or equity – of 40 per cent or more. These borrowers can get rates of 2.74 per cent for a two-year discounted tracker from Principality Building Society or a five-year fix at 3.99 per cent from Clydesdale Bank.

According to Adrian Anderson of mortgage broker Anderson Harris, would-be landlords need to make sure the rental income of a property will be good enough to cover the mortgage, plus a margin.

“This varies between lenders, but the rent should be at least 125 or 130 per cent of the mortgage amount to satisfy the lender,” he says.

Experts say first-time landlords should be careful not to over-gear themselves. Adam Stackhouse, director of developments, investments and new homes at Marsh & Parsons, the estate agent, recommends landlords to put down a big deposit.

“Always aim for a 35 per cent deposit, as additional charges such as management and service contributions and void periods can place pressure on income levels and repayments,” he says.

Tim Hyatt, head of lettings at Knight Frank, agrees, noting that landlords should also put money aside for refurbishments and general wear and tear repairs.

“What is different now is that a tenant is far more demanding than they used to be. They expect service, they expect quality of the product and they expect good management,” he says.

Investors should also make sure that there is enough tenant demand in the area in which they choose to buy so they are not left with long costly void periods.

“Successful buy-to-let investments are ones where occupancy rates are very high and the tenant is able to pay the bills,” says Stephen Ludlow of ludlowthompson, the estate agent.

Listen to the FT Money Show podcast on how yields of 6 per cent on rental properties are tempting investors into the buy-to-let market. How some bank staff steal customer data and whether the Post Office can become a challenger to the big banks as it prepares to offer current accounts

He believes that investment decisions should not be based on yields alone. “Investors would be well advised to consider capital growth prospects as well as income yield,” says Cook. “Prospects for value growth are typically much higher in London and the South East, particularly in some of the lower yielding markets where there is a stronger core of owner-occupier demand.”

Ludlow recommends looking at properties within a short distance of London. “The residential ‘zone two’ ring around central London produces some of the best buy-to-let investments in the country because rental income is very high for the cost of the property, meaning good yields, and it’s relatively easy to find tenants who will be able to pay the bills because of the high number of jobs within easy commuting distance.”

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Tax advantages too

Buy-to-let has become an increasingly popular alternative – or supplement – to traditional pensions or investments, and it can produce better yields than cash savings given today’s low interest rates, writes Mike Crellin, principal tax manager, UHY Hacker Young.

Rental property provides regular income for a landlord and potential profits once it is sold, but landlords should also be aware that buy-to-let offers opportunities to reduce tax bills too.

For example, landlords must pay 28 per cent capital gains tax (CGT) on the profits they make from the sale of their property, but in some situations this bill can be reduced, or removed, if the landlord lives in the property for a period of time.

Buy-to-let landlords can also deduct allowable expenses from the tax they pay on their rental income. Allowable expenses include, but are not limited to: letting agent fees, service charges, repairs, safety certificates, redecorating, Contents insurance, Wear and tear to carpets, curtains, and more in furnished lettings.

Our experience is that buy-to-let landlords tend to have other income, which can make buy-to-let less attractive if they are paying 40 or 45 per cent tax on their rental income after expenses. However, if buy-to-let properties are bought with mortgage finance the interest can be offset against rents for tax purposes.

Quite often, the combination of mortgage interest payments and expenses leaves little or no taxable profit – and little or no tax to pay.

If a mortgage triggers a loss, this can be carried forward against future rental profits.

In areas with high rents, where there is still be plenty of profit after expenses and mortgage interest, buying the property jointly with a spouse or civil partner with a lower tax rate can reduce the tax burden, and could also take advantage of unused personal income tax allowances.

Buying a property with a spouse or partner might also help when it comes to a sale, as each owner has their own annual CGT exemption.

But a note of caution: landlords need to remember to report everything to HM Revenue & Customs. A self-assessment tax return needs to be filed to report rents and expenses – and landlords must tell HMRC that they need to file a tax return, if they don’t already. This is just general guidance, and it is always advisable for landlords to seek advice from a professional accountant to make sure they are fully compliant with HMRC.