Last year was the end of an era. I sold the Modern Flat, after owning it for over 20 years.
A bit of history
I ended up with my Modern Flat in that common way that many ‘accidental’ landlords have. It was my first rung on the property ownership ladder. Until it was time to get onto the second rung. I thought I’d live there for several years – though in practice I lived there less time than I had originally expected.
The flat itself is a new build flat in central London, to a reasonable spec. It is slightly bigger than average, but has no outdoor space whatsoever. I loved living there, albeit that was a long time ago. It had a great reception space but rather cramped bedrooms with insufficient storage. This suited me fine – bedrooms are for sleeping in, and living rooms are where you live. The building had a residents’ association, a management company, and a porter. I bought the flat on a long 200+ year lease, and had to sign up to both a ground rent (doubling every 25 years) and a service charge (set by the management company).
I managed to climb onto the second rung without selling the Modern Flat. Instead, I kept it, ever since, I rented it out. This isn’t, strictly, a ‘buy to let’ property in that I didn’t buy it to let it.
I haven’t strictly treated my Modern Flat as an investment. As an illiquid asset, I don’t track it as part of my invested portfolio. Nonetheless, my decision to sell it was mostly financially driven.
Buy to let financials – the theory
The case for being a landlord, as I see it, has three key financial arguments in its favour:
An inflation proof asset. Bricks & mortar are the classic ‘inflation-proof’ asset. They are ‘safe as houses’, etc. Even in property crashes prices usually don’t fall too much in nominal terms. And if you get lucky you can see very healthy gains. Property prices are usually linked to wages, which rise faster than inflation (assuming some level of productivity growth). Since 2000, average wages have increased 3.58% per year, slightly higher than the CPI inflation index which has risen 2.65% p.a.
With attractive regular income. Rent is a very tangible form of income. Your rental yield is probably between 3% (for a prime property in e.g. a quality London neighbourhood) and 10% (for a rather low rent student type property outside London). It’s usually paid monthly, and it almost always goes up over time. As above, economists will observe rents tend to rise in line with wages, not prices. My initial rental yield was around 6%, though more recently it has been lower. It’s worth noting that it isn’t necessarily compounding income – because you can’t readily deploy it right back into real estate – but it certainly promises to supplement the monthly cashflow.
Boosted by leverage. Property is one asset class that people expect to fund via debt, at least partially. Mortgage interest is not a deductible expense for your own residence, but it is deductible on an investment property (though less so than it used to be before George Osborne’s reforms).
It’s worth mentioning tax here. Taxes here are relatively favourable, but have been worsening.
Gains from selling high buying low are taxed as capital gains, which has a lower tax rate than income tax. The good news is that the slightly higher rate that property attracted compared with other assets such as stocks & shares has been eliminated by Rachel Reeve’s October 2024 budget. Now all capital gains tax rates for individuals in England are 24%. Which is a lot better than 40% or 45% marginal income tax rates. CGT rates are the same across the UK, whereas in Scotland income taxes are slightly higher.
And of course income tax – which is how rent is taxed – is taxable at your marginal income tax rate, but subject to some deductible expenses including some relief for mortgage interest. The rules here are not as generous as they used to be but they still are a bit more favourable than for stocks & shares. But stocks & shares deliver a good chunk of their return through capital gains, which are taxed much more favourably. In contrast over the years your rental property’s return feels like it is mostly coming from highly-taxed income.
Annual real estate tax isn’t really a thing for UK landlords. In the UK it is called ‘council tax’ and framed as paying for local services such as street lighting, bin collection, etc – is a liability falling on the occupant, not the owner. In this respect it is quite different from, say, the USA’s system – as I understand it. It is also a relatively low tax by international standards; not that most landlords really care because they usually don’t pay it.
Buy to let – the practice
The financial arguments in favour of renting, laid out above, are not wrong. But they are incomplete and oversimplistic.
In practice, the real world doesn’t usually behave exactly like the theory describes. And specifically in my example of a relatively prime London property, as rented out here was my reality:
Net rental yield of 2.7% was far lower than my gross yield of 4.9%, after deducting
Service charge – of £7,500-£8,000 per year. Compared to service charges in central London these days, which often cover gyms/swimming pools/24-7 porters, this service charge was quite modest. The average for the building was lower but my flat was above average in size.
Mgmt fee – to my management agent – of 12% of the annual rent. This is quite a high fee, though certainly not the highest it gets. A managing agent is something landlords would dispense with, but see Time section below.
Ground rents – of £700 per year, after doubling recently from the initial £350 p.a.
Insurance – a minor cost of £150 per year. Most of my insurance cost is handled under the service charge; this £150 cost is just for my contents (kitchen appliances, etc) that are not covered under the building insurance.
Mortgage interest, at about 6%. This cost ended up being around 15% of my gross yield, thanks to a small mortgage. And since buying the Coastal Folly three years ago, I wasn’t repaying any mortgage principal – instead focusing my free cash flow on my margin loan.
Leverage is expensive. As it happens, my mortgage was small; I originally borrowed 75% of the purchase price, but later repaid a significant proportion of the original loan. Meanwhile the property’s value has risen. So my loan has been under 15% of the property’s value for some time. For many years, post 2008, this cheap tracker loan was practically free money. But since base rates rose to around 5%, the loan has been a real expense. And only partially deductible. But if I’d had a five times larger loan, i.e. the original LTV when I bought the property, current interest charges would have put me into the red – even without making any mortgage repayments.
Time/hassle – planned. There is a certain amount of regular faff that comes with being a landlord. Electrical and gas certificates need to be up to date, and renewed annually. EPC certificates need to be refreshed every 10 years. And so on. My property has been in pretty good nick so I haven’t had much work to do it. And I’ve had a managing agent to help co-ordinate annual certificates. But this is all work and stress that doesn’t come with stocks & shares. The looming drama is the tightening regulations about minimum EPC standards; my property was just about EPC C but only by a whisker. But anybody with a D, E or worse needs to make improvements by 2028.
Time/hassle – unplanned. The unplanned work is the real dread. Fortunately I had relatively few “the boiler is broken” calls. But they have happened – and my managing agent was only really a conduit – she wouldn’t do anything without getting instructions from me. A washer/drier needed replacing, a dishwasher needed replacing, a boiler needed replacing, and that’s just what I remember. The time spent on these was not enormous – but the interruption value could be very annoying. A broken boiler does not respect a holiday, an important deal you are trying to close, or just a flat-out week. More significantly, I had a large building project nearby which led to a Rights to Light party wall process, which was quite a significant bother – requiring multiple professional advisers. I did get a useful cheque out of this process but it made dealing with the occasional Corporate Action elections in my stocks&shares portfolio seem trivially simple by comparison.
No capital gains for 7+ years. With wage inflation averaging 3.5% a year, you’d have thought my property would have appreciated by about the same over that time period. What’s actually happened is that it appreciated quite significantly between 2000 and about 2015. But over the last 7 years I don’t think it rose in value at all, and in fact quite possibly fell in value by 10% or more.
There is an additional kicker on the capital gains, which is tax. As an ‘accidental’ landlord, the first period of my ownership – when it was my principal residence – is tax free. But as the rental era grows, my tax-free period is shrinking. Which means that my capital gains tax liability is growing every year, even if the property value itself is flat.
This reality left me sitting on an asset which was netting me a total return of around 2.5% a year, pre tax, over the last 7+ years. This was ignoring the value of my time – which for unplanned interruptions is a very generous assumption. It also ignores the rising capital gains tax liability, which was around £1000 per year.
And – ouch! – the transaction costs
I resolved some time ago that this landlord lark wasn’t something I wanted to sustain. However I wasn’t so upset by it as to want to disrupt my tenant, and in fact my last tenant was a very good tenant in almost every way. So I let things sit until the tenant gave me notice he wanted to move out, almost a year ago.
I set about selling the flat. This is not something I have much experience in. I considered three agents, in the end appointing one who seemed to have the best understanding of the building and the local market. I negotiated an acceptable fee, though when you add on 20% VAT you are talking almost 2% of the value of the flat.
After a very opaque period of marketing and viewings, I received a small number of offers. I accepted one offer – in a small chain – and ultimately sold the flat to that buyer some months later, at that offer price. I didn’t get the price I was after but I felt that I had enough visibility into the market that I don’t think I was to far off. However potentially I could have held out for 2% more, maybe even 5% more.
As the dust has settled, the transaction costs are now clear. And they are painful.
I ended up completing on the sale almost six months after the tenant left and stopped paying me rent. This lost rent was over 2% of my sale price.
In actual costs, plus very clear opportunity cost, this transaction cost me 4-5% of the value. In potential value foregone, from a somewhat opaque market price, potentially I also endured a further 2% hit. This is fully a year’s gross yield, and an order of magnitude higher than what happens with listed stocks.
Returns analysis
So, what return did I get?
I looked at this in a 2023 blog post. As it turns out, this post overestimated my returns because a) since 2032 I have had no capital gain and b) the flat wasn’t worth as much as I estimated back in 2023.
The property value more than doubled under my ownership. This rise worked out on average as just under 4% p.a. When you allow for the Rights of Light payout, we can call it 4% per year.
My equity rose eightfold during this time. That works out as 9.5% p.a. compound return on equity. That is more respectable. Leverage made a big difference here. But very very close to my stocks/shares 14 year average return too.
My total return is higher still, as it would add in my net income (after fees/etc). I don’t have this recorded/analysed over the last 20+ years. In recent years the net yield has been around 2%-3% on average. But initially, when gross yields were higher, my return on equity from the yield alone was probably at least 10%. So on that basis my long run returns on equity have probably been around 15%.
Two key points strike me here.
Returns are highly dependent on leverage – and indeed the cost of leverage. When interest rates were low, from 2008 for over 10 years, there was free money on the table – especially if you could pick properties that were appreciating in value. This was why the Tories started to first pluck, and then strangle, the golden landlord goose.
Returns recently have been miserable. My total return over the last 5+ years has been under 3% per year. This barely tracks inflation. My decent long term return all happened in the first 10 years.
So, I’m out, and I’m moving my capital in search of better risk-adjusted effort-adjusted returns. More on that in a follow-up blog post.
How does my experience compare?
Those of you with rental properties, please share in the comments below how this compares with your experience.
And I’d very much welcome thoughts on how to deploy the capital released. In particular I’m looking for something which shares the same positive qualities as rental property, but with fewer of the negatives. Thoughts welcome!