It is a common knowledge that buying an investment property can be one of the most secure, rewarding and fastest ways to build significant wealth. When buying investment property the steps are not drastically different from that of buying property to occupy as a home. When looking for your first property in the United Kingdom to invest in, you need to understand some basic information before you proceed.
The UK is one of the few countries in the whole world that uses leasehold/freehold property ownership system. It confuses a significant number of people looking to buy rental properties in the UK as they do not fully understand the nuances of these ownership types.
Simply put it, leasehold is a fixed term property ownership and can expire if not extended. Freehold ownership is absolute ownership of land and building in perpetuity whereas leasehold only gives a right to use prescribed area. Leasehold property owners have a landlord who owns the freehold.
Leasehold ownership is mainly made for apartments in blocks. There are around 4.3 million leasehold properties in the United Kingdom. Whilst freehold ownership is mainly reserved for houses, commercial buildings and land.
Leasehold properties attract service charge which is an annual payment made to the managing agent of the building for the upkeep and maintenance of communal parts. The service charge budget is raised by appointed managing agents and all leasehold properties owners are obligated to pay it. If payments are late leasehold property owner can be in a lot of trouble and in some extreme cases have their property forfeited.
Risks When Buying Leasehold Property
As mentioned above, leasehold properties have an expiration period similarly to grocery products. Upon expiration, leasehold property goes back to the freehold and landlord can take possession. Leasehold properties come with a lease which is a legally binding contract between the landlord and the leaseholder. Usually, residential property leases in the UK are granted for a term between 99 to 125 years.
The problem with leasehold properties is that when the lease term remaining dips below 80 years it has implications on property value. UK mortgage lenders are not particularly keen on lending any money to purchase leasehold property with 80 years or below remaining on their lease. Because of this situation, once a remaining term on the lease dips below 80 years property starts losing value.
You can always extend the leasehold property term and there is a statutory law which gives a right to extend the lease for an additional 90 years providing the property has been owned for at least two years. The lease extension premium becomes payable to the landlord and often runs into thousands of pounds.
Leasehold properties also attract an annual payment which is paid to the landlord and is called ‘ground rent’. It is a practice originating from English feudal times when tenants were paying ground rent to the landlord for the right to use the land. Usually, ground rents for leasehold properties currently range from £1 to £1,000 per annum. It is widely accepted that if annual ground rent does not exceed 0.2% off the property value then it is reasonable. If it does then it might be difficult to get a mortgage.
These are the drawbacks of leasehold property ownership, however, where there are drawbacks there are also opportunities. Buying leasehold property with a short lease can be extremely rewarding due to the significant discount which can be obtained from the seller and then subsequently extending the lease to increase value. A lease extension is an intricate matter and involves surveyors and solicitors. Before buying leasehold property with a short lease, it might be a smart idea to obtain a ballpark extension costs via lease extension calculator.
The UK has one of the strictest tenant rights in the world. The residential property law is geared towards tenants more than landlords. In recent years, the Landlord and Tenant Act have been changed severely impacting all landlords in the UK. If the tenant is late on paying rent and falls into arrears the whole eviction process can last between 6 – 12 months and sometimes longer depending on the tenant circumstances. Tenants cannot be evicted without a court order and simply them falling into arrears is not enough. The tenant needs to be at least two months into arrears before notice can be served to the court which then sets a hearing date.
Recovering arrears from the tenant can be a nightmare and many landlords just choose to let it go because in some cases it can cost more in professional fees than the sum of arrears itself.
Stringent referencing checks before signing a tenancy with the tenant are key to ensuring an optimal rental property performance.
Property Income Taxation
UK Government has changed the law on how residential properties are taxed and made it more difficult for landlords to make a profit. The issue is that if a residential property is bought with a mortgage under a personal name the mortgage interest relief sums up to only 20% instead of the previous 100% relief rate.
This is not applicable when buying rental property via a limited company and full interest relief can be claimed on annual returns. However, running administration costs of investment properties held in a limited company can be higher cutting down on profits. It is always best to speak with a qualified accountant to determine the best holding structure when buying a property in the UK.