The end of a calendar year is often a time to reflect on the old year and make plans for the new. It has particular relevance in finance because the start of a new calendar year means the end of a financial year. This can have major implications for tax and hence financial planning in general. With that in mind, now seems like a good time to reflect on buy-to-let as an investment class.
Why buy-to-let became popular
At a high level, buy-to-let is arguably the safest form of investment there is. People always need somewhere to live. Not everybody can own a house and, even if they can, they may not want to.
For example, younger people may prefer the flexibility of renting. Older people may want to divest themselves of property to minimise their estate’s inheritance tax liability. This means that it’s probably safe to assume that there is always going to be some level of demand for rental property.
Buy-to-let can also be one of the easiest forms of investment to manage. In fact, investors don’t really have to manage it at all in any practical sense. They can hire a letting agent to take care of the practicalities for them. They can also hire an accountant to deal with the financial aspects of running a buy-to-let property.
The potential pitfalls of buy-to-let
Investing in buy-to-let, by definition, involves buying property. The cost of property means that investors need to be prepared to commit significant capital before they see any income. In fact, investors may even need to use financing (mortgages) to buy property.
If investors miscalculate the returns a property could make, they could find themselves having to swallow a painful loss. If they only hold the property for a short time, it may not appreciate enough in value to cover the transaction costs of buying and selling it.
Investors may also find themselves having to deal with problematic tenants. Letting agents will do their best to resolve issues without the involvement of the landlord. At the end of the day, however, if the situation gets really bad, the landlord will have to decide whether or not to pursue legal action.
The alternatives to buy-to-let
Currently, there are two main alternatives to buy-to-let. These are commercial property, and short-term lets. Here is a quick guide to how they compare to residential buy-to-let.
Commercial property
The main commercial property market tends to work similarly to the bond market. Investors buy a stake in a commercial property. In return for this stake, they get a guaranteed income for a guaranteed time. At the end of this time, the investor either sells the stake back to the management company or renews it.
The advantage of this approach is that the investor gets a guaranteed income (assuming the management company remains in business). The disadvantage is that investors generally do not benefit from any increase in property prices.
Short-term lets
Short-term lets are classed as commercial property. They are, however, usually discussed separately since they tend to operate differently. The main reason for this is that investors typically buy a whole property rather than just a share of one. This means investors can benefit from increases in property prices.
The main advantage of short-term lets is that they have the potential for significant returns. The main disadvantage of short-term lets is that they generally require a lot more work than residential property.
Investors should also be aware that the government and/or local authorities may start clamping down hard on short-term lets. They could essentially force investors to move into regular buy-to-let or sell their properties.
YOUR PROPERTY MAY BE REPOSSESSED IF YOU DO NOT KEEP UP REPAYMENTS ON YOUR MORTGAGE
The FCA does not regulate commercial mortgages and we act as introducers for it
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