Don’t get burned by the buy-to-let boom: Funding retirement with rental income could turn into a disaster

Eighteen years after the creation of the first buy-to-let mortgage, this form of investing has been a goldmine for many. The stigma that was once associated with being a landlord has been swept away and there are now 2m in the UK, who together own one in five homes, according to research from mortgage lender Paragon. The government expects landlords to own one in three homes by 2032.

 

Meanwhile, house prices have continued to rise, and are up 36 per cent nationally over the last ten years, according to the Halifax House Price index. 

 

The government’s pensions freedoms, which came into effect on Monday, have removed the requirement for savers to buy an annuity. Instead, over 55s will be entitled to take some, or all, of their pension as a lump sum. 

 

The sudden availability of a large pot of cash alongside the seemingly lucrative appeal of the buy-to-let market means many experts are predicting a boom in the numbers of older landlords ­– or “granlords”.

 

Banks and building societies have moved swiftly to capitalise on the trend, and Nationwide has altered its lending criteria to offer new mortgages to people up to age 70, with a maximum term of 35 years. 

 

There are several reasons why cashing in a pension to buy property seems an ideal way to fund retirement. “Buy-to-let mortgages are treated as a commercial, rather than consumer, product and are therefore subject to fewer regulations,” explains Matthew Pointon, property economist at Capital Economics.

 

Buy-to-let investors can access mortgages with higher loan-to-value levels, deduct mortgage interest payments from their rental income before paying tax, and are also able to take on interest-only mortgages.  

 

But withdrawing pension savings to invest in buy-to-let could be a “costly mistake,” says David Smith, financial planning director at wealth manager Tilney Bestinvest. 

 

He emphasises that only 25 per cent of a pension can be taken as a tax-free lump sum, with the remaining 75 per cent taxed at the individual’s marginal rate. This will eat into the pot available to buy a property. This sum will then be whittled away by the costs of buying a property, including solicitor’s fees, valuations, searches and stamp duty – not to mention any refurbishment costs.

 

House prices have already risen significantly in recent years, and while their future direction is anyone’s guess, retirees will still be buying in the midst of a market bull run.

 

“I wouldn’t go near the South East. Prices have risen massively,” says Rob Bence, director at property investment specialists RMP Property.

 

As with any house purchase, the location is absolutely crucial. Bence recommends taking a look at northern cities including Manchester, Liverpool, and Leeds, where the market has been calmer. “Prices in those cities have hardly moved at all since the crisis and they are just starting to pick up now.”

 

There are also property funds offering investors income from a portfolio of residential or alternative properties, such as student accommodation or hotel rooms, but Bence urges caution to anyone looking at these. “Unfortunately there are a lot of people targeting those using retirement pots, and a lot of the schemes look suspect,” he says. 

 

Many people underestimate how difficult it can be to manage a property, and this is even more troublesome for the elderly. “We see a lot of widows who are left with a buy-to-let property at age 82. We are dealing with people who are getting more and more vulnerable every year,” says Stephen Ford, director at wealth manager Brewin Dolphin.

 

Bence has seen horror stories and always recommends using an agency to manage the property, despite the cost. “What looks like a nice investment can suddenly become a nightmare… when people buy property and the tenants in the area are of poor quality,” he says. But again, the ongoing agency fees will reduce retirement income. 

 

Retirees should also remember that inheritance tax will be payable before the property can be passed on to heirs, and capital gains tax will be levied following a sale ­– which both diminish the overall value of the pot.

 

“To add insult to injury, upon sale of the property, any gain made on the value could potentially be subject to capital gains tax of up to 28 per cent,” says Smith.