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Property investing has always been conceived as a fairly safe way for generating long term gains. Particularly in the recent environment with the Bank of England base rate being at the lowest point in history (0.1%), there are some extremely cheap financing deals to be sourced. But what about Tax and how can you invest in property and being Tax efficient at the same time?

This article assumes that there are surplus funds (let’s say £50,000). These funds have been generated from other trading profits and are not immediately required from the same business. Later in the article we will show you that can get started from as little as £12,500.

Property Acquisition Options

For the sake of keeping the article relatively simple, we will be discussing the typical methods of purchasing properties:

  • Cash
  • Buy to let (interest only)
  • Capital repayment

Cash Purchases

Quite simply these types of investments are made purely in cash with no finance backing up the transaction. This has the following advantages:

  • Quicker completions
  • Possibility of sourcing cheaper properties as some sellers may look to drop the value for a quick sale
  • Slightly reduced legal fees due to the less complex purchasing methods
  • Greater cash flow due to zero finance costs.

Let’s back this up with an example, and say a property is being purchased for £50,000. Other assumptions being made is that the property is being purchased through a property company (not as an individual). One final assumption is that we are including 3% stamp duty being the standard BTL rate for companies.

These charges increase to 5% for property purchases for more than £125k, and as high as 15% for acquisitions where the property is being transferred for more than £1.5m (https://www.gov.uk/stamp-duty-land-tax/residential-property-rates). It therefore makes sense to look for properties for less than £125k.

Property Cost: £50,000
Legal Fees: £750 (estimated)
Other Fees: £250 (tenant finders fee)
Stamp Duty: £1,500
Total upfront cost: £52,500

In the area of Peterlee, Durham, such a transaction would be expected to bring in around £450 per calendar month. Some property investors may seek the services of a letting agent to ensure collection of rent, and general other management. Their fees would typically be 10% and we have factored these costs in the ROI (return on investment) calculations below:

Monthly rent: £450
Management charge: -£45.00
Provisions for repairs: -£45.00 (estimated 10%)
Monthly surplus: £360
Annual surplus: £4,320
Annual ROI: £4,320 / £52,500 = 8.2%

We can see from this particular investment that the acquisition should return on average around 8% on an annual basis, much better than what you would get from keeping your money in a savings account where rates are at 1% at best. Of course, with these calculations we are not taking into account annual appreciation. Hopefully over the course of twenty years you would expect the property to rise in value.

In summary, from an investment of £52,500 we are making positive cash flows of £4,320. Payback time would be just over twelve years.

Whilst 8.2% isn’t a bad return, using finance you can greatly increase your ROI (return on investment). Let’s now look at a BTL (interest only mortgage).

Buy to Let Purchases (Interest Only)

These types of purchases are known as BTL purchases, where the property is financed up to 80% of value and the only repayments are the monthly interest payments. Terms would usually be between 20 and 30 years where the full loan should be repaid in full at that time. At this point, people would either sell up, or refinance for another 20 to 30 years.

Let’s take the above example, and apply BTL financing to the concept.

Property Cost: £50,000
Legal Fees: £750 (estimated)
Other Fees: £250 (tenant finders fee)
Stamp Duty: £1,500
Total cost: £52,500
Financed: £40,000
Upfront cash required: £12,500

The annual cash position is pretty much the same, but now we have interest payments. Let’s presume the rate is 2.5%.

Monthly rent: £450
Management charge: -£45.00
Provisions for repairs: -£45.00 (estimated 10%)
Interest payment: -£83.00
Monthly surplus: £277
Annual surplus: £3,324
Annual ROI: £3,324 / £12,500 = 26.6%

These returns are clearly way greater than cash purchases, and furthermore – we have only invested £12,500 which means out of the £50,000 we initially had available, we could essentially make four of these purchases:

Annual surplus for four properties of £50,000 financed at 80% will produce annual cash flows of £13,296. The payback time of your initial investment would be just under four years.

Capital Repayment Purchases

These types of mortgages are the more standard type of home ownership finance, where the property is financed up to 80% of value and the repayments are the monthly interest payments and include some capital repayments. Terms would usually be between 20 and 30 years where the full loan should be repaid in full at that time. For this example we are assuming a 25 year pay back period

Let’s take the above example, and apply standard capital financing to the concept.

Property Cost: £50,000
Legal Fees: £750 (estimated)
Other Fees: £250 (tenant finders fee)
Stamp Duty: £1,500
Total cost: £52,500
Financed: £40,000
Upfront cash required: £12,500

The annual cash position is pretty much the same, but now we have interest and capital repayments. Let’s presume the rate is 2.5%.

Monthly rent: £450
Management charge: -£45.00
Provisions for repairs: -£45.00 (estimated 10%)
Mortgage payment: -£179.00
Monthly surplus: £181
Annual surplus: £2,172
Annual ROI: £2,172 / £12,500 = 17.4%

Although the returns are not as good as BTL financing there is still a good ROI of 17.4%, and likewise – as we have only invested £12,500 which means out of the £50,000 we initially had available, we could essentially make four of these purchases:

Annual surplus for four properties of £50,000 financed at 80% will produce annual cash flows of £8,688. The payback time of your initial investment would be just under six years. You also have the advantage of no final capital payment at the end of the loan term.

How to Extract the Money from Your Trading Company?

Put simply there are two ways to do this, the first option being to withdraw the money as a dividend – attracting dividend Tax at the rate of 7.5%, increasing to 32.5% if you’re a higher rate Tax payer. This would mean that if you were to pull £50,000 from your trading company, you will have a Tax bill of at least £3,750 later.

Not only this, but if you were to make the property purchase in your own name (not a company), interest payments are not deductible for Tax purposes for higher rate Tax payers. This can have a big impact on your returns.

The better and more Tax efficient way of utilising the surplus funds would be setup another company dedicated for property investing (let’s name this Property Co Ltd). The trading company (let’s call this Trading Co Ltd) would then lend £50,000 to Property Co Ltd. As this transaction is a loan, and is not a dividend – there are no Tax consequences for this movement. Property Co Ltd would have the full £50,000 available to use as investments. And using the BTL method above, you could easily be looking at annual net cash flows of £13,296 (25%) and above.

You may have spotted that the net cash flow of year one – £13,296 is not too far away from the initial upfront cost of buying a property financed at 80%. Essentially this means that within one year, your returned profits could be used to add another property to your property portfolio. Should these returns be sustainable, and all profits recycled within the company, this could be a general forecast of your portfolio:

Summary

As you can see, by using a company with BTL financing, property investments can be scaled up very quickly and with our assumptions it is possible that you could be looking at annual cash flows of £40,000 within five to six years from an initial investment of just £50,000.

Please don’t forget that you can also start from a smaller bank roll, say £12,500. This would produce surplus cash flows itself of £3,324.

Disclosures

This article is not intended to serve as financial advice, but purely to offer information on the different ways and means that a property portfolio can be developed in a Tax efficient manner. We would recommend that you seek the services of a professional Financial Advisor that could lay out the appropriate routes for financing and other general investment options.

Please feel to post any questions you may have below, or if you would like more information, please don’t hesitate to drop us a line.