RISING interest rates, falling yields, more red tape and a crackdown on unpaid tax by Revenue & Customs: 2007 is proving a difficult year for buy-to-let investors. Interest rates have risen four times since last August, increasing the cost of a £150,000 loan by £125 a month. The Government introduced new buy-to-let regulations in April 2006 and 2007, and plans to increase the regulatory burden on landlords next year. Rental yields continued a decline that began in early 2003, with average yields now well below 6 per cent. To make matters worse, the Inland Revenue has reportedly identified 80,000 property investors – one in five of the UK’s 400,000 buy-to-let landlords – who may be liable for extra tax on their properties.

TAX

If you are concerned about your tax liabilities, speak to an accountant as soon as possible. “The cost of several hours of an expert’s time is considerably less than the tax bill you could receive if you choose not to do so,” says Lee Grandin, managing director of Landlord Mortgages. There is a government tax amnesty until June 22, so if you have extra payments to make you should come clean now to avoid penalties.

But Mr Grandin says that the vast majority of buy-to-let investors have nothing to worry about. “There is little need for the professional landlord to be concerned with this news. The main target for the Revenue will be those who are selling properties and not declaring the sale for capital gains tax.”

Landlords must pay stamp duty on their investments, income tax on their rental payments, and capital gains tax on their profits when they sell their property. When paying income tax, you are permitted to deduct allowable expenses from your rent. Those include: mortgage interest (but not capital) payments, letting agent fees, legal and accountancy fees, buildings and contents insurance, maintenance and repairs. Home improvements are not tax deductible. Nor can you deduct capital costs, such as the cost of furniture.

Capital gains tax (CGT) is payable at 40 per cent on any profits over and above the CGT threshold, which is £9,200 this tax year. The longer you hold on to your buy-to-let property, the lower your eventual CGT bill will be: taper relief reduces the amount of CGT that is payable by 5 per cent a year after three years, up to a maximum reduction of 40 per cent.

YIELDS

Rental yields have been declining gradually since early 2003, because of a combination of rapidly rising house prices and static rents. Figures from Landlord Mortgages show that the average yield in England has fallen from 6.3 per cent at the end of 2004 to 5.7 per cent this year.

However, it could be that the rental yield picture is about to change. House price growth is likely to slow this year, while healthy rental demand could push rents higher. The National Association of Estate Agents says that the increase in immigration from Eastern Europe, buoyant employment conditions and strong demand from those who cannot afford to buy property is contributing to a thriving rental market. Rents have risen in the first quarter of this year by an average of 1.8 per cent, the association says.

MORTGAGES

Your mortgage is likely to be by far your greatest expense as an investor, so keeping repayments as low as possible is critical. “With four rate rises in less than a year, and at least one more expected by the end of the summer, landlords are feeling the squeeze,” says Melanie Bien, a director of the mortgage broker Savills Private Finance. “Mortgage costs are rising far quicker than rents.”

Anyone coming to the end of a three or five-year fixed-rate deal is likely to be facing a huge increase in monthly mortgage repayments. While you may not be able to achieve the rates possible a few years ago, you can insulate yourself from the end-of-fix shock to some degree – but you must act quickly. “If you are coming to the end of a fixed-rate deal, it is important that you sort out a remortgage before the end of the fixed term, so that you don’t slip onto your lender’s standard variable rate and end up paying more than you need to,” Ms Bien says.

Where you go from here depends largely on where you think we are in the interest rate cycle. For the majority – those who believe that a further rate hike is on the cards – a fix makes sense. Alliance & Leicester has a two-year deal charging 5.89 per cent, with a £999 fee. If you believe that we have already reached the top of the interest rate cycle, a discounted tracker is a cheaper bet. Birmingham Midshires has a tracker charging 0.36 percentage points below the base rate, giving an initial pay rate of 5.14 per cent. The fee represents 1.5 per cent of the loan amount, but the valuation and legal fees are free.

“Even with three further quarter-point rate rises – which the market has not factored in – you would be no worse off than with a variable rate product,” Ms Bien says.

REGULATIONS

Over the past few years the regulatory burden on landlords has increased considerably. In April 2006 came the mandatory licensing of Houses in Multiple Occupation, which means that, if you are the landlord of a property that has three or more storeys with five or more tenants in two or more households, you must obtain a licence from your local council. Licences can cost anything from £150 to well over £1,000, depending on your local authority.

Under the Tenancy Deposit Protection scheme, introduced on April 6 this year, landlords in England and Wales must hand over deposits given them by tenants to an approved scheme, which will hold on to the funds until the end of the tenancy. In the event that there is a dispute, money will be held by the scheme until a resolution is reached and a decision made on how to allocate the funds.

Next April will see the national rollout of the local housing allowance scheme, under which housing benefit will be paid to tenants’ bank accounts, rather than directly to private landlords. Some landlords have argued that this could lead to certain at-risk tenants falling into arrears and eventually being evicted.

From October 2008, landlords will be required to buy energy performance certificates, just like the ones that will be included in home information packs. The certificates will cost about £200 and rate homes on a scale of A to G depending on where they rank on an energy performance scale. The certificates will be valid for ten years and it will not be necessary to buy a new one for each tenancy. Jewels of the North East, page 31

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THE OPTIMIST

LAURENT EZEKIEL, 33, left, has protected himself from any future price falls by ensuring that he retains a share in each of his buy-to-let properties. This will allow him to hold on to his portfolio of ten flats in East London, even though he believes that his appetite for investment would dry up if the market stagnated or fell.

Ezekiel does not believe in worrying about rental returns, which in few cases seem to cover management and agents’ fees: “They are a zero-sum game. The only way to make money from property is by one day selling up at a profit.”

But it is the prospect of paying high levels of capital gains tax that prevents him contemplating selling any of his £2.8 million portfolio, even if the market turns. Fortunately, he believes property prices will continue to rise in London: “The slowdown hasn’t started. Loads of properties are still going to sealed bids.”

Ezekiel turned investor in 2003 when he remortgaged the £400,000 West Hampstead flat he shares with his girlfriend; the £290,000 Hoxton flat he bought is now worth £450,000. He has since expanded strongly, purchasing flats in Poplar, Stratford and the Canary Wharf area, all designed to appeal to young professionals. He pays his father, a professional property manager, to oversee the investments, which allows him to carry on with his career in advertising.

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