In this video, I cover four disadvantages of purchasing Buy to let properties as a passive income strategy. This video is aimed at those who are perhaps thinking of buying one or two buy to let's rather than a portfolio of properties. Transcript below if you prefer to read.

Transcript

Today, I will cover four disadvantages of Buy to let properties as a passive income strategy. As a Chartered financial planner, this is exactly what I share with my clients who want advice and are looking to buy their first or second residential property to rent out. Many change their mind after hearing the logic. Also, I provide alternative strategies to get passive income that are more tax efficient, cheaper and less cumbersome to manage.

I am not talking about buying a property to live in yourself; or even a second home that you use a lot; that is a different consideration as when you buy to live in a home,it is quite different to buying as an investment.

Hi! I am Cleona, founder of Conscious Money and on this channel, I give you honest strategies around being free and clear with money.

Familiarity Bias

Before we talk about the disadvantages, two points. I can see why buying property is appealing. People know property in their gut; they have sometimes seen their parents and grandparents get great returns from property; it is often a decision that comes from this strong internal conviction. I get that. This familiarity to stay within a felt comfort zone can also be a cognitive bias, called a familiarity bias.

Ability to leverage with a mortgage

Also, another reason why property is attractive is you can create more wealth by borrowing or leveraging your gain with a smallish, say 25% deposit in the property and a mortgage on the rest. This ability to leverage is a seriously huge advantage with property investing. I would never encourage you to borrow money to invest in the equity markets. Leverage can also quickly amplify your liability in a market downturn.

So, noting familiarity bias and ability to leverage...Now, to the disadvantages.

Disadvantages

Diversification

If you already live in and own a UK residential property, your wealth pie has a large chunk of the UK property market. Why buy more slices of the same pie?

The concept of diversification implies that you create a portfolio that includes multiple investments in order to reduce risk. Therefore, logically, you would invest in other asset classes - bonds, stocks, commercial property, etc. You could even buy a global property tracker fund or REITS (Real Estate Investment Trusts) if you were keen on the property angle - just own it in a more diversified way.

Tax

If you are a UK taxpayer, rental income is taxed like earned income. By creating more income, you are not really in control of the (tax) leakage. Here, think of a water pipe flowing towards you albeit with a hole. I am not against you paying taxes; however, I am all for smarter ways of putting your money to work.

There is also the higher stamp duty to consider on second homes now and of course, capital gains tax when you eventually sell the property.

Liquidity

Housing is not a liquid asset to sell. It can take months, people can change their minds easily after committing and one needs patience in the selling or negotiations process. There are costs to buying and selling a rental property too, it is not a cheap investment transaction to get into.

Life energy

You also have to consider the life energy and hours involved in managing the property & tenants. Even if you outsource it to an agent, it involves some of your time to manage that relationship and oversee decisions as it is ultimately your home. You also have to consider the life energy -if you have a call about the boiler or the washing machine being broken, it is slightly aggravating.

An interesting point: At the time of making this video, (December 2020) the current dividend yield on the FTSE 100 is 4.81% so not bad. The UK average rental yield is about 3.53%.

There are Other tax efficient ways to invest - ISA's and Pensions

Pensions as you know have the additional benefit of effectively increasing the basic rate tax band.

Capital gains is tax payable on gains made via other investments such as investing in mutual funds. It is much kinder to your pockets, payable at a lower rate than income tax. Plus you can use ISA allowances to wrap these investments and preserve tax efficiency. You could even aspire to be an ISA millionaire and have tax-efficient income.

Bubble?

The UK has a high proportion of privately rented homes owned by individuals and the perception is that investors have been crowding out owner-occupiers. Property prices usually rise over time, somewhat in line with inflation- in the last decade or so, however, we have had an unusual scenario of cheap borrowing and much financial support with schemes for new buyers to get on the housing ladder; Property prices have gone up quite sharply. Having said that, bubbles can stay bubbles for a long time.

So, to recap: please consider diversification, tax, liquidity, transaction costs of buying and selling, bubble-esque environments.

There are other choices that always exist to create income if you need income. I am referring to more efficient, diversified ways of building wealth by investing in equity funds where you can take a fixed income or natural income from the capital.

I hope you got some value out of this video. if you did, hit the like button for me, leave a nice comment - it really helps and hope to see you again in the next video.

Tax notes:

Your rental profits are taxed at the same rates as income you receive from your business or employment – 0%, 20%, 40% or 45%, depending on which tax band the income falls into. Your rental income gets added to any other income you earn, which could tip you into a higher tax bracket.

You’ll usually have to pay capital gains tax (CGT) when you sell the property you have been letting. Special rules apply if the property is or has been your home. Otherwise, the property is treated in the same way as the sale of any other asset, and you'll pay either 18% (if you're a basic-rate taxpayer) or 28% (if you're a higher or additional-rate taxpayer).