Many buy-to-let landlords have been left spitting feathers in the wake of George Osborne’s changes to mortgage interest relief on rental income. A typical response goes something like this: “I’m running a business here. Interest payments are bills the same as any other… be it the agency fees, or boiler repairs… why can’t I fully offset my interest fees in the same way any other business does?”
But it’s simply not true that many of these amateur landlords run businesses the same as any other. This long-held tax advantage has caused severe changes to the nature of the residential market. Osborne is right to “level the playing field” as he says, between buy-to-let and first-time-buyers.
How tax relief has skewed the housing market
The ability to net off interest payments against taxable income has provided a big incentive for landlords to load up debt. I know many an amateur landlord who’s raised as big a mortgage as possible against a second property, and used the funds to pay off debt on their main residence.
On a main residence, you have to pay your mortgage interest from post-tax wages. It’s far better to shift the debt over to a rental property, thereby paying the mortgage interest from untaxed earnings. This is what Osborne is saying when he talks about levelling the field between owner-occupier and tenanted property.
But of course, the existing tax loophole has had a far more pernicious effect than mere tax planning. To make the most of the tax break, many landlords cyclically remortgage, taking out as much equity from the property as possible, thus releasing capital to fund new properties. By ransacking the equity, and ensuring repayments are of the ‘interest-only’ variety, they build a dangerous empire.
This is what largely explains the phenomenal growth in the buy-to-let market over recent years. Given the supply constraints on housing, the most insidious effect has been to drive up house prices. As prices go up, so equity continues to be released, re-invested and the game continues. As the landlord’s portfolio balloons, so paper profits look great.
But because of capital gains tax issues, the landlord isn’t ever really in a position to cash-in. If they sell, they’d have to give up a large proportion of the profit to the taxman. That may leave too little equity to repay the mortgage. Remember, the guy wasn’t ever repaying any of the mortgage capital. He was just raising ever-more debt.
I can see that many of these landlords now find themselves in a tricky situation. Ever-higher house prices have squeezed rental yields, and many of these businesses are running on very tight margins. But what the moaning minnies of the sector fail to realise is that it is the tax break itself that’s suckered them in ever further. Low interest rates have kept the scheme intact.
Bank of England governor Mark Carney rightly worries about the buy-to-let market, and says he’ll investigate. Just think what a surprise rise in rates will do to many of these fragile businesses.
There’s nothing wrong with being a landlord – but you have to be sensible
First time buyers, meanwhile, have been hung out to dry. Either they pay big rents even while they try to save for a deposit, or they have to pay grossly inflated house prices – the mortgage payments of which come out of their post-tax income.
So Osborne is quite right to realise that some air has to be taken out of this balloon. And sensibly, he’s phasing in the changes, giving landlords time to realign portfolios and plan for a bit of pain.
And the typical landlord’s comeback – that “rents will have to go up to compensate the landlord’s increased costs” – flies in the face of economic reality. Landlords and their agents, like any other business, seek to maximise profits – rental income in this case. That’s simply a supply and demand issue. One cannot raise rents, just because profitability changes. Landlords that do will only end up with big rental voids, and then they’ll really be in a pickle.
Before I start sounding like a crazed anti-entrepreneurial loon, let me just say that I have no problem with the vast majority of the rental sector. For landlords who stick to sensible policies on debt, leverage can be a big benefit.
But what seems wrong is the chain-letter-type growth of amateur businesses, wreaking havoc in the market. Osborne is right to have identified and started to deal with the culprit. If this move does nothing more than curtail the growth in an avaricious market, then it will be a good thing.
Thankfully, this part of the market isn’t big enough (yet!) in itself to cause a housing crash. But if the tax changes were to encourage landlords to release some housing stock back onto the market, that too will be a good thing.
This government made the promise of helping individuals re-establish their place on the property ladder. And this seems a sensible policy in pursuance of that aim. Not to mention de-risking some dodgy business models.