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Tax, lending, and how to grow in today’s market

Thursday 30 November 2017

By Tony Gimple

With section 24 due to hit landlords on their 2017/18 tax returns, and now the Prudential Regulatory Authority (PRA) tightening up on borrowing, I know many landlords who feel like they’ve got a big ‘Kick Me’ sticker on their backs. And I don’t blame them.

Particularly for those landlords making tax payments on account, there’s going to be a big impact on cash flow - and as a result on their ability to invest.

But is it really all so doom and gloom that property investors should be throwing in the towel?

I don’t think so.

In fact, I think there’s an opportunity for savvy landlords to make highly sustainable profits by running professional property businesses.

And the good news is, that’s exactly what the government wants you to do! 

Governments everywhere are basically businesses just like yours. And the way they turn a profit is tax. And they need successful individuals and organisations to be making money in order to be paying them that tax.

Section 24 aside, that basic principle could actually play into your hands if you play it right.

Let’s take a closer look at what the latest PRA changes actually mean for landlords…

1. Lenders will be looking at your whole buy-to-let portfolio

Commercial portfolio lending already works this way – residential lending is just catching up. This is the way all the truly big property businesses borrow money. It doesn’t matter whether we’re talking hundreds of properties or just a handful - the same principles apply – and the business case trumps all. And it’s the business case that buy-to-let lenders will now be looking at.

Too often, landlords have grown their portfolios with very little planning, and as a consequence not every rental property is profitable. Some lenders may take an ‘overall portfolio profitability’ view, whereas others will require each unit to make money.

Either way, the new rules mean that lenders will need to make sure your rental income makes you a profit before they can lend.

2. Lenders will have tougher underwriting criteria for portfolio landlords

According to the PRA, “A landlord will be considered to be a portfolio landlord where they have four or more mortgaged buy-to-let properties across all lenders in aggregate”.

In addition to the usual affordability checks, lenders are being required to have robust underwriting processes in place for portfolio landlords, which means they’ll be asking for: -

  • Bank statements

  • Tax returns

  • Future liabilities

  • SA302s

  • ASTs

  • Rental accounts

  • Income and expenditure statements, and

  • A business plan.

Make sure you’ve got them.

3. There’ll be a new stress test on buy-to-let mortgages

The stress test will force lenders to check a borrower can afford their repayments if (or when) interest rates hit 5.5%.

Anyone who lived through the early 90s will remember interest rates hitting 15% - so we need to keep 5.5% in some sort of perspective. It’s not the worst threshold in the world, and affordability is actually as much in your interest as in theirs.

Be warned though - lenders will be taking into the impending changes as to the amount of tax relief landlords can claim against mortgage interest.

As we all know, Section 24 changes can easily make a basic-rate taxpayer a higher one, or push a higher-rate one into advanced rate. If you’ve not done your maths on this yet, do it now.

And remember - it’s not just the tax increase that hurts. The cumulative effect on your cash flow when making payments on account and the knock-on effect to your borrowing ability should not be underestimated.

In essence, paying more tax will reduce how much you can borrow and therefore grow

This more than anything will cause the biggest problems, and if you want to borrow more, then minimising the amount of tax you have to pay is essential.

But don’t rush to incorporate. Too many landlords had this knee jerk reaction, and too many will regret it. Rate differences, restrictive terms, redemption penalties, and transactional costs to one side - limited companies are subject to seven layers of taxation, further reducing your profit and thus how much you can borrow.

4. Lenders will want your business plan, and they’ll want it to be good.

As the saying goes, failing to plan means that you are planning to fail – and no lender wants that. Not only does having a well thought through business plan make borrowing easier, it significantly increases your chance of becoming financially solvent whilst you’re still young enough to actually enjoy the odd holiday or luxury.

A good business plans doesn’t have to be complicated. In fact you’re better off keeping it simple. It’s just a written document that clearly states what your financial targets are, why they are important, how they are going to be achieved, and whether your current investment strategy will actually get you there. Focus on the hard numbers that prove you can get where you want to be. If it doesn’t add up, it won’t add up to a loan.

Remember to include:

  • All your sources of income (not just rents)

  • a summary of your experience in residential investment property

  • details of the operating model

  • tenant profiles

  • the supporting business infrastructure (including professional service providers, letting agents, solicitors, accountants, property management, etc.)

  • details of any voids / tenant defaults / evictions that you have experienced and how these situations were managed, together with what plans you have to manage those in the future)

  • your future funding requirements for the next 18 months, and

  • proposed future purchases, improvements and disposals including property type, tenant type, sources of funding and funding voids during improvements etc.

5. There’ll be much less leeway in every direction

Lenders are nervy. And they’re going to be even more cautious. They won’t for instance, be taking rental rises into account – or only to a very limited degree. When assessing affordability, a mortgage lender might look at rental increases, but they won’t assume they’ll exceed the Government’s inflation target of 2%.

Some (like Santander, for instance) have already said they won’t accept applications from portfolio landlords for the purpose of personal capital raising. Basically, if you’re having to remortgage just to get the money out because the rents aren’t high enough and you’re relying on house price inflation - you’re in real danger of going bust.

In summary:

Buy-to-let lenders want to know:

  • Your property investment experience

  • The total amount of your mortgage borrowing across all properties

  • Your assets and liabilities, including tax liability

  • The merits of any new lending in context of your existing buy to let portfolio together with your business plan

  • Historical and future expected cash flow from your portfolio

  • Your income both from property and elsewhere.

  • If you’re running a professional property business, then you’ll have all of this to hand and be confident in the numbers. 

If not, expect a hard time.
It’s time to take the ‘Kick Me’ sticker off your back, and replace it with the one that says;

“I’m a professional landlord with a thought through deliverable business plan with maximised returns and the lowest tax bill the law allows. You can lend to me with confidence”.

Tony Gimple
Less Tax for Landlords
Lesstaxforlandlords.co.uk

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Article by:

Tony Gimple

Tony Gimple

Tony Gimple has worked for Legal & General, American Express, Towergate, Chancery Law Group and Bowling & Co Solicitors (a Leading Legal 500 firm where he was their estate planning director), and is the subject of a Cranfield MBA thesis on entrepreneurship.