Is commercial property the answer to residential landlords’ problems?


rent freeze

Recent tax reforms and regulatory changes have hit buy-to-let landlords hard, and now there’s another obstacle for investors – a potential rent freeze in London. It’s a major worry for the capital’s investors, who are set to lose anywhere up to around £20,000 a year if the freeze is implemented.

As London prepares to follow in the footsteps of Berlin, are buy-to-lets worth the hassle?

Almas Uddin, managing director at Revolution Finance Brokers takes a look at some alternative solutions and how investors are looking to commercial properties as a more lucrative alternative:

Things haven’t been easy for buy-to-let landlords recently. Regulatory changes, raised interest rates on mortgages and new rules for HMO landlords have created a wealth of problems for both landlords and lenders. There has been the scrapping of the ‘wear and tear’ allowance and the introduction of an additional 3% stamp duty for buy-to-lets.

And in April 2017, the Section 24 Act was implemented, otherwise known as the Tenant Tax. The statute means that landlords will now not be able to claim mortgage interest or other property outgoings as tax deductible, and rental profit and costs will be taxed at the basic rate of 20%. Although it doesn’t affect landlords who own homes outright, anyone with a mortgage will see a much bigger tax bill and a smaller yield. Landlords who are in the higher tax bracket of 40% or more will be hit the hardest. It will be rolled out in stages: as of April 2019, higher rate tax relief can only be applied to 25% of mortgage interest costs, while 75% will be at the basic rate. By April 2020, landlords will only be able to claim the basic rate of tax relief, which could double or triple the amount of tax owed.

But there are ways to minimise tax bills, some of which are outlined below.

  1. Transferring property to a spouse or relative in a lower tax threshold


  1. Incorporating property into a limited company, which is exempt from Section 24

However, this isn’t an easy option as transferring property into a limited company is likely to incur stamp duty costs, capital gains tax, remortgage fees and early repayment penalties from lenders. That’s not all: landlords will have to pay corporation tax on profits, and taxed on company withdrawals.

  1. Placing the portfolio in a Beneficial Interest Company Trust

This allows landlords to move the economic value of the property into a company but retain the legal title of the property and the mortgage in their name, so it does not require remortgaging. But switching from income tax to corporation tax incurs professional fees. Also, lenders will far be less likely to finance future properties if they see that properties have been placed in this type of trust as a way to avoid tax.

  1. Avoid the higher tax bracket

Make higher pension contributions for tax relief, or make charitable gift donations.

  1. Remortgage to make lower monthly payments

As more lenders join the market, there is a growing trend of incentives such as fee-free and cashback deals, and the competition means that lenders are trying to tempt landlords with good rates.

Other options include selling underperforming properties and/or raising rents.

How likely is the rent cap?

As young professionals find it increasingly difficult to save for a first mortgage in large cities, a rent freeze seems imminent – and recent polls suggest the public is overwhelmingly supportive of such changes. While Mayor Sadiq Khan has no statutory power over landlords, he has already delivered on pledges to end letting agent fees; introduced a new database to ‘name and shame’ rogue landlords and worked with London boroughs to tackle poor living conditions.

Along with his intentions to control rent in the capital, he is also keen to end the Section 21 Act and introduce longer secured tenancies. And the Government aren’t opposed to the idea. In April this year they announced their intention to consult a similar set of proposals to those set out by the Mayor.

There are alternatives to rent control, such as the provision of more affordable housing, but this is a long-term solution and the Mayor has lobbied for something more immediate. Another solution would be for the government to introduce a top-up for those struggling to meet higher rents, but this has yet to be debated.

What this means for investors

Research carried out by flatshare website ideal flatmate estimated losses of over £19,000 per year in London and around £5,300 in England and Wales as a consequence of the potential rent freeze.

Landlords in London have seen their yields decline to just 3.18% in the past month, the lowest in the country, according to the May 2019 report from LSL. It also shows a 1.1% decrease in the monthly rents.

As letting agents are no longer allowed to charge any fees, the price of property management has gone up. Along with the tax and regulatory reforms, some landlords have raised the rents on properties, while others have sold their properties and exited the residential industry altogether.

Are residential buy-to-lets worth it?

There’s no denying that the buy-to-let market is looking more and more uncertain. But while many investors have sold up, there are still good yields to be had with residential properties in London, and some investors negotiate significant price reductions when buying property.

How commercial property can fill the void

But it’s not all doom and gloom. With every setback comes a solution, and more investors are finding that solution in commercial and semi-commercial property. And when you look at the benefits, it’s not hard to see why.

The commercial property market is generally split into two groups: larger properties such as shopping malls and large office blocks, or smaller ones like newsagents and restaurants.

The appeals of investing in commercial buy-to-lets are numerous, and this way a lot of landlords can avoid many barriers to investing in residential property

Firstly, there are the higher yields:

The return on commercial buy-to-lets are typically higher than residential properties. With yields on residential properties in the South East hovering at 3%, plus costs; landlords are left with very little at the end of the month. The yield on commercial properties fairs much higher and has been steadily rising as residential yields have been in decline. Reports from Savills have calculated June 2019 yields at around 6% and Knight Frank report yields of up to 10% in London and the South East. And as the tenancy leases are generally in terms of years, rather than months, landlords have more financial security. Also, the tenant, not the landlord is obliged to pay for all repairs and expenses.

Secondly, the stamp duty and land tax (SDLT) on commercial properties is lower, and they are not subject to the same 3% stamp duty surcharge as residential buy-to-lets. This also applies to semi-commercial properties. So if, for example, you purchase a shop with a residential area above it, the whole building will be charged at the lower SDLT rate.

Thirdly, there is no Tenant Tax on commercial properties. The Section 24 Act only applies to residential properties and commercial landlords will still get the benefit of tax relief. Also, as the Loan to Value (LTV) rate is falling for residential buy-to-lets, from around 85%-90%, to 70%-75%. Experts predict that the LTV on residential properties will fall further to 65%, meaning there won’t be much difference between the LTV on residential and commercial properties.

Many commercial tenants are in demand of smaller units, as the trend for e-commerce means that consumers are growing in favour of buying online, and topping up their shopping at smaller stores. Also, most businesses do not require all the floor space needed previously to house paperwork! In London, tiny retail units like Boxpark – a food and retail park made out of shipping containers – are incredibly popular and footfall is high. So there is a real increase and advantage to splitting commercial properties, either to incorporate a residential property or make way for more businesses.

Of course, it’s not for everyone and there are things that investors should consider before jumping in at the deep end. It’s a different venture altogether and investors should seek advice from a commercial agent.