Buy-to-let: what are the alternatives?

It appears Britain’s obsession with property investment could be hitting the buffers. The traditional attractions of regular income and long-term capital growth are colliding with a new economic reality of higher interest rates and an increasing tax burden. But the nail in the coffin for many buy-to-let landlords, who are planning to sell up in record numbers, is the frustration and uncertainty of new, tighter legislation.

Buy-to-let legislation changes

Landlords already have many legal obligations including gas and electrical safety certificates, deposit protection and fire safety standards, as well as hidden expenses such as appropriate insurance, maintenance and repairs. But a raft of new rules for buy-to-let landlords is increasing the load.

For instance, net zero targets mean that some landlords will need to spend thousands of pounds on energy improvements to ensure their properties comply with the Minimum Energy Efficiency Standard (MEES) for privately rented homes.

While the number of regulatory hoops to jump through are bothering some landlords, fair and professional actors with good-quality, energy efficient properties probably have nothing to fear except some extra administration and cost. Yet changes to the legal framework, specifically the potential impact of the Renters’ Reform Bill, are also causing concern.

The main part of this bill could eventually abolish Section 21 or so-called ‘no fault’ evictions. It means a tenancy could only end with no reason if a tenant decided to do so. Landlords would instead need to apply for possession through other means, creating ambiguity as to the length of time it could take to get rid of a bad tenant and the costs involved.

Diminishing returns on property investment

The increasing regulatory burden and uncertainty would perhaps be more tolerable for the UK’s landlords if they hadn’t already been seeing returns eroded from rising mortgage rates and higher taxes. Typical fixed-rate buy-to-let loans are now priced at around 5.6%, compared with 3.4% only two years ago. Meanwhile, income tax has become more onerous with a gradual reduction of mortgage interest rate relief from 2017.

Previously, landlords had been able to deduct the interest they paid on their mortgage from their taxable rental income, but now relief is only available via a flat rate tax credit at the 20% basic rate. This generally makes buy-to-let inefficient for higher or additional rate taxpayers. Setting up a company to own the property can potentially reduce the tax burden for higher earners taking a professional approach, but this does come with its own complications and expenses.

The tax crackdown extends to profits on any sale, too. Capital Gains Tax (CGT) applies on secondary properties at basic and higher rates respectively of 18% and 24%, compared with 10% and 20% for other assets, although the higher rate did reduce in the Spring Budget from 28%. With the annual CGT allowance falling from £12,300 a couple of years ago to £3,000 in 2024/25, any property paper gain is going to be considerably less after tax. Unlike holding readily tradable assets such as shares that can be sold in stages, it is not possible to use CGT allowances over different years to save tax.

Financial challenges for buy-to-let investors

The evaluation of any prospective buy-to-let investment ultimately comes down to the prospects for income, growth of that income and the potential for capital appreciation. As such it needs to be compared with the returns available on other assets.

Higher inflation and interest rates increased the ‘risk-free rate’ of return available on safe investments such as cash or government bonds. This depressed the value of all assets as investors demanded higher return for taking risk. The same principle ought to apply to rental property. An acceptable income yield in buy-to-let may have been as low as 3-4% in an era of close-to-zero interest rates, but what should it be now they are much higher? Seen through this lens, many properties may not stack up as good buy-to-let investments, even as rents are rising.

Buy-to-let alternatives

Funds, shares and other investments can arguably offer better alternatives to buy-to-let for long-term capital growth and income without the aggravation, as well as much greater opportunity for diversification – spreading your money around to reduce risk.

Yields on UK shares for instance average around 3.7% and it is possible to generate income significantly in excess of this by focusing more on dividend-paying companies. All yields are variable and not guaranteed. Markets, it must be pointed out, have their downs as well as ups, but if you are appropriately invested and sufficiently diversified then income tends to be much more stable than capital value.

When investing in the stock market or other assets it is possible to minimise tax very effectively. One option is to pay into a pension such as a Self-Invested Personal Pension (SIPP) and get tax relief on the contributions. Investments housed in a pension are also free from income tax and capital gains tax. From age 55 at present, you can then start accessing your pension to provide yourself with an income.

You can also invest in the stock market through tax-efficient Individual Savings Accounts (ISAs). These can be accessed at any age and returns and withdrawals are tax-free.

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