5 Reasons Buy-to-Let Is Less Attractive for High Earners
As someone who makes a living advising on tax-efficient investment portfolios of stocks and bonds, I may be biased on this subject.
So let me start by trying to answer:
In which circumstances can buy-to-let work well?
Those with the right skills, dedication and some luck: You will have a huge advantage over the average landlord if you can get a good deal on your purchase price, you're skilled at DIY, you have a knack for hiring decent tradesmen, and you have time for getting involved in renovation projects and sporadic repairs/maintenance. And while a letting agency can cover some of these areas, you would still need to be able to choose the right agent, oversee their performance and factor their fees into your investment return.
Those with a genuine need for income: If you are not working full time and you are not immersed in a career, having a buy-to-let property can provide a vital source of income. For some people, the role of being a landlord suits them well and the prospect of getting a full time job can feel very remote and unrealistic for a variety of valid reasons.
Those who cannot stomach the volatility of stock market prices: The conventional alternative to investing in a rental property is to own a diversified portfolio of stocks and bonds. Because these types of investment are so quick and easy to sell, the consequence is that, for every single working day of the year, you are essentially being quoted how much you could sell your portfolio for. Such information can be incredibly overwhelming, leading to unnecessary stress/excitement and potentially harmful financial decisions. A common solution is to stop logging into your investment account and ignoring financial news where possible, but this is easier said than done and not always the wisest approach. If you compare this to owning bricks and mortar, which still carries plenty of investment risk, most people do not truly know the market value of their property until they actually try to sell it (often many years after buying). They are not focused on daily or monthly valuations and they tend to recognise that what they actually own is still intact regardless of someone's offer to pay less than the original purchase price on a given day.
Those who already have a good deal: If you already have a reliable tenant and you are getting a decent net return (with all costs and taxes carefully considered), then of course it makes sense to be happy with the current situation.
Those who value feeling that they are in control of their investment: You can touch property, you can decide what colour to paint the walls, you can meet your tenants face-to-face, you can arrange your own mortgage and choose what happens with the money that you have borrowed. This feeling of knowing what's going on can be a lot more grounding than the abstract nature of the stock market, which frequently baffles even the most experienced investors.
Now let's look at some of the drawbacks of buy-to-let.
Why Buy-to-Let Is Less Attractive for High Earners
1) Costs add up
It is very normal to look only at the rental yield – that is, how much rental income you receive each year relative to the property's value. However, it's easy to overlook the costs that start to add up, including mortgage interest (currently around 5%), insurance, maintenance costs, unexpected repairs, letting agent fees, accountancy fees, void periods without tenants or even legal disputes with tenants.
If you are considering a buy-to-let investment, it is well worth taking the time to calculate your expected return after allowing for these ongoing costs, rather than relying on the headline rental yield alone.
2) Political risk
In a post-2008, post-COVID, inflationary world, inequality has become the topic du jour. In addition, it feels like there's some form of housing crisis in every part of the world.
Landlords are a typical target in this debate, putting them at risk of unfavourable changes to taxes, rules and regulations. Combined with the friction involved in selling property, it is easy to see how some landlords might feel trapped and exposed.
While wealth of all forms may well be a target for future taxation, having more liquidity for your investments enables you to adapt to changes more efficiently.
3) It is time-consuming
Being a landlord is not as passive as people think - it can be like a second job. If you have a full time career or you run a business, you may find that you are better off putting in the extra hours trying to boost your income through your profession rather than potentially spreading yourself thin with this additional responsibility.
If you invest your savings in the stock market, your money really does work for you. If you own a global equity index fund, you are indirectly a shareholder in thousands of companies from around that world that each have executives and employees working hard to deliver profits to you. Of course, such profits are certainly not guaranteed – losses can occur and investment values can fall as well as rise irrespective of the underlying business performance.
4) Compounding requires more effort
For long-term wealth accumulation, compounding is extremely powerful. £100,000 growing at 9% per year over 30 years will be worth £1,326,768.
While the value of a buy-to-let property can rise over time, its rental income does not automatically get added back to increase the value of your investment. To compound your wealth further, you would need to save this rental income and use it to buy the next property.
Comparing this to the stock market, much of the compounding from company shares happens within the businesses themselves. Companies can reinvest profits to expand operations or make acquisitions - in this case, they are doing the compounding for you. Where dividends are paid out to shareholders, these can be automatically reinvested to buy more shares.
As mentioned previously, if you need the rental income now, then buy-to-let can work well. However, if you are working full time and your aim is to build wealth over the long term, adding rental income to your taxable earnings each year may not be the most efficient way to achieve that goal.
5) Tax Inefficiency & Illiquidity
From April 2027, rental income will be taxed at 42% for Higher Rate taxpayers and 47% for Additional Rate taxpayers. If you already earn a high salary, this taxation represents a significant deduction from your investment return.
For practical purposes, when you sell a property, you usually need to sell the whole thing. The process can take anywhere from a few months to a few years.
Once the sale takes place, the buyer usually needs to pay Stamp Duty and you would likely need to pay Capital Gains Tax of up to 24% where there has been any profit on the sale.
By contrast, an investment portfolio of stocks and bonds can usually be sold within a few days. Crucially, you can sell almost exactly how much you want, whenever you want. This flexibility creates significant opportunities for intelligent tax planning:
Adults can contribute up to £20,000 per year into a Stocks & Shares ISA, where investment growth is tax free. This means you and your spouse or partner could collectively move £40,000 per year into a tax-free environment.
Subject to various limits, you can also receive income tax relief by contributing to a pension. For example, someone earning a salary of £120,000 per year could contribute £60,000 to a pension and benefit from a wide range of significant tax advantages that are beyond the scope of this article.
For those with very high incomes or a high net worth, 'Investment Bonds' can provide a structure that defers tax on investment growth until a more favourable point in the future.
Inheritance Tax planning is also much more flexible when you are able to sell portions of your investments instead of having too much tied up in property. There is a variety of tried and tested solutions for assets that are liquid and divisible - from making regular gifts to placing lump sums into trusts.
Conclusion
I hope this article has shown that there is no single solution for everyone and that there is a lot to think about.
At the same time, I think the article provides some background into why those who are already immersed in their careers might choose to build long term wealth through tax efficient investment strategies.
As always with investing, your capital is at risk and the value of investments can fall as well as rise. What works best will depend on your goals, time horizon and risk appetite.
If you would like to arrange a consultation, please email contact@robertskeens.com.
Investment Disclosure:
This article is provided for general information only and should not be relied upon as personalised financial, investment or tax advice. The performance of your investments is subject to risk(s). Performance may fluctuate based on movements in the market and economic condition(s). Capital at risk. Currency movements may also affect the value of investments. You may get back less than you originally invested. Past performance is not a reliable indicator of future performance. Tax treatment is based on individual unique circumstances. Property values can also fall, and buy-to-let investments carry risks including periods without rental income, unexpected costs and changes to tax legislation. I do not advise on mortgages but can refer a mortgage adviser upon request.