Wednesday 1 April 2015

Pension Or Property?

By Chris Chambers. Chris is the owner of Yeovil-based firm, Proudhouse Property Management. Chris is also an experienced landlord, and property developer, with his own portfolio of houses and flats in Cardiff and Yeovil. 

This article augments information provided at www.proudhouseproperty.co.uk

This article aims to provide information for our landlords, tenants and potential clients. All opinions are our own and do not constitute formal advice; none of the content is intended to form a contract or promise of services outside of our Service Agreement. Please feel free to browse these articles and use as an informative resource for lettings and property management. We would be delighted to discuss your needs in more detail; for Lettings in Yeovil, Sherborne, Somerset and Dorset please contact us on 01935 388456


Pension Or Property? 
Property rental as an alternative to an annuity?

This month pension rules will change - it will become easier for pension holders to draw cash out of their pension pots and it is anticipated that many people will use this opportunity to invest in property. If you're in this situation then you should be sure that you are taking the best financial decision based on your circumstances and tax situation; if in doubt then you should seek the advice of a financial or tax adviser.

Withdrawing money to invest in Property
The first 25% of a pension pot can be withdrawn tax free; the remainder can be withdrawn and you will be taxed at your marginal rate. So if you have a £400,000 pension pot then you can withdraw up to £100,000 tax free. The rest of this article will concentrate on how you could invest this money in property. If you have multiple income streams, or do not understand the tax implications then you should consult a financial adviser.

Investment Strategy
If you have never invested in property then you maybe wondering where to start; is property investment as simple as buying a house and renting it out? You may be thinking you want to buy a property outright, with no mortgage, and enjoy a monthly income of several hundred pounds a month. Perhaps you are considering a mortgage but don't know whether a repayment mortgage or an interest-only mortgage is best for you. Lets look at some examples based on a cash fund of £100,000 and an annual increase in value of 3%:

  • A. Outright ownership: £100,000 should be enough to purchase, outright, a reasonably modern 2 bedroom flat. Advantages: 1) no mortgage therefore no mortgage fees/interest, 2) protection from changes in interest rates, 3) If you have the time, are local, and fully understand your role as landlord, then you could probably manage the property yourself. Disadvantages: 1) Bad tenants or empty periods will provide you with no income, 2) A poorly chosen property (ie not in demand by tenants) in the wrong area could leave you with no income, 3) We're assuming value will increase but it must be borne in mind that your capital is invested in one concentrated asset which could go down in value or, in extreme cases become worthless should an unforeseen event happen eg; subsidence, fire, etc. Value increase after 1 year: £3000
  • B. £100,000 deposit on a large house: It's tempting to think bigger is better - £100,000 used as a 33% deposit on a 66% LTV mortgage of £300,000 could purchase a quality 4 bedroom house. Is this a better option than outright ownership as in example A? See the paragraph below on rental yield. Value increase after 1 year: £9000
    How to spend money?
  • C. 2 x £50,000 deposits on 2 flats at £100,000 each: Advantages: 1) As long as void (unoccupied) periods do not co-incide then some income, if not all, can be expected every month, 2) Better chance of protection from value decreases, 3) Capital gains could be made on 2 properties. Disadvantages: 1) Interest rates can change, 2) More management work. Value increase after 1 year: £6000
  • D. 4 x £25,000 deposits on 4 flats at £100,000 each: This approach involves leverage of the £100,000 fund across several assets in the hope of increasing gains. This approach would put you into portfolio landlord territory. Advantages: 1) Good redundancy against void periods, 2) Good redundancy against price decreases (assuming the properties have been purchased in different locations), 3) Good chances of capital gains. Disadvantages: 1) Workload - you will almost certainly want to use the services of a managing agent and will incur their fee (of course, using a good agent, such as Proudhouse Property Management, will ensure you can sit back and enjoy your investments without the day-to-day burden!), 2) Mortgage fees and interest rates start to increase at high LTV, 3) High administration burden - even if you are using an agent, you will still need to be organised with administration and keep track of costs, fees, interest payments etc in order to take best advantage of allowable expenses in the context of tax and self-assessment. This applies to all of the examples, however, more properties requires more work. Value increase after 1 year: £12,000 
The above examples are very simplistic but I hope they show the broad strategies that could be followed. There are many, many more variables to take into account; ground rents, service charges, mortgage fees, arrangement fees, maintenance costs, insurance and not least rental income - on the subject of rental income you should have a basic knowledge of rental yield.

Rental Yield
It is useful to have some sort of financial reference to gauge how well a property rental is performing in terms of income versus investment. That reference is called rental yield. However, it is not as simple a calculation as some agents and advertisers would have you believe - calculation of a true rental yield needs to take account of running and maintenance costs and this can only be calculated once a property has been acquired and been let for a period over which the actual costs can be ascertained. However, a simple rental yield calculation for use as a very basic measure for comparing properties at the buying stage is:

(Annual rental income divide by purchase cost) multiplied by 100

So for example; a £100,000 flat will rent for £600 pcm

(600 x 12) / 100,000 = 0.72
0.72 x 100 = 7.2%

If you use an agent then ensure they
are ARLA registered.
The higher the percentage the better! Anything at 6% or above would be considered to be a good rental yield. However; do the calculation again but this time subtract agents fee, insurance costs, 1 month rent (assuming one void period), accountants fee, anticipated maintenance costs, gas safety check fee etc from the annual income. The percentage will be a lot lower! Bear this in mind at the purchase stage and use this method of rental yield calculation with caution.

But what about capital gains tax?
CGT is only payable when the equity is released - furthermore there is a £11,000 allowance before CGT taxation takes effect. And this is your pension plan - you're probably investing for the long term, or even until death! 

Give your property away! (and make a will)
Think about what will happen to your property when you die - one huge advantage of property over an annuity is that your children can inherit property. Take legal/tax advice on this but it may be that you can gift your property to a child and, as long as you don't pop your clogs inside 7 years, your children should not be liable for inheritance tax. You would not be able to claim any rental income if you did this. An alternative could be to part-gift to a child; annual part-gift increments could be managed in such a way that the value of the gift is below the recipients annual CGT allowance of £11,000. Part-gifting would mean you could still benefit from the property and receive rent.

Summary
Attempting an article on property investing in one blog post is pretty much impossible! There are whole books devoted to it - but I hope this has scratched the surface and provided some basic fundamentals. As an alternative to a pension, rental properties can be an excellent option. There is much research to be done - don't rush in; start looking early, get a feel for the market and feel free to approach us for a lettings consultation. We of course would be delighted to offer you advice which is completely free. We have an excellent lettings and property management service and would love to hear from you. 01935 38845

email: chris@proudhouseproperty.co.uk 

  

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