If a recap on interest rates and Scottish property transaction taxation is not necessary, and you’d prefer to read about solutions not problems, then you may prefer to skip forward to the next section.
A brief recap
The market went from 6th gear to reverse with a crunch on 30 September 2022 as the incoming (and soon to be outgoing) UK Prime Minister announced radical fiscal policy in an attempt to fuel growth amidst towering inflation rates and a cost of living crisis. Contrary to these grand plans, the market reaction was to sharply increase the interest rates on mortgage products in anticipation of a chain reaction of Bank of England base rate rises. The quickly replaced UK Administration helped to ease fears a little and BTL mortgage deals have settled back to more serviceable rates of around 5% (and as low as 4.29%).
The dramatic slowdown of property transactions is already evident, and auctions for repossession properties will already be gearing up for some busy times ahead.
Yet, in true SNP style, the Scottish Government would like to further put the breaks on the housing market by increasing the Additional Dwelling Supplement (ADS) due on 2nd and additional homes by 50%, from 4-6%. At the time of writing thats double the ADS tax currently in place in England and Wales. Such is the contrast between the vote hungry SNP and the pro-growth Conservative party (for all its faults).
During the cost of living crisis, The SNP have also put in place an emergency eviction ban (ensuring evictees are given minimum 6 month notice to quit) and also a temporary rent rise ban. Neither of these short term emergency policies takes into account the huge hike in mortgage payments that landlords will have to endure in the short-mid term. And all this when rental stock is at a critically low level. It’s not clear exactly how they envisage falling numbers of landlords could ever increase, or even sustain current levels of rental stock?
So are the SNP making life just too hard for property investors in Scotland?
In short, no. But a change in strategy is required.....
Given that for much of the 90s right up until early 2008 interest rates averaged out at around 6%, one would be encouraged to take the view that the return to 5-6% mortgage products are less the ‘new normal’, and more a case of ‘as you were’ - An adjustment back to the old ‘norm’. Property investment strategy must attempt not to mourn the ‘glory days’ of cheap debt, but rather accept the re-adjustment and move forward.
Strategies that worked through the past 15 years need to be changed. As interest rates rise, the interest-only cash flow model seems less and less viable and arguably only works now if it is scaled up to a large portfolio scale to counter the eroding margins. You could go for a high-yield option in a more deprived area but do you really want your eggs in a basket that has historically proven to be the worse performing locations for capital depreciation in times of recession and low growth?
As discussed in our previous blog on the pitfalls of over-marketed cheap ‘deals’, history shows us that the smart money in times of low growth are in affluent cities such as Edinburgh or south of the border in London, Cambridge, Oxford and the Home Counties. These areas saw comparatively strong growth in the 10 years subsequent to the 2007/8 ‘credit crunch’, vastly outperforming more industrialised locations like Glasgow, Liverpool and Manchester that are more exposed to unemployment and affordability constraints.
Yet unlike our English counterparts, the locations where growth was most impressive happened to be in expensive cities with far less comparative rental yields maxing out at 4%. Edinburgh, in contrast, performs remarkably well for a capital city at an average of 6% gross yield in sensible investment locations. And rates of average 8% for HMO properties.
On The SNP transaction tax issue If, as an example, we consider an average property investment for an Edinburgh landlord of £200,000. The increase from a 4% to a 6% ADS tax represents a further £4000 investment. So the answer is fairly simple, in the wake of 2023’s huge opportunities, investors must try to ensure that the discount on the market value on a property factors in this extra premium.
The alternative approach for more established investors is to take advantage of the ‘6 property ADS exemption’, that is, buy 6 or more properties in one transaction and pay no ADS whatsoever. This has never been so appealing considering, if we take our £200,000 example, that represents a whopping £72,000 saving across the 6 properties. (Some may view that as a ‘free’ deposit on property number 6 should the purchase be financed).
We will say little about the other method to escape ADS tax which is to buy properties for less than £40,000 which would qualify for 100% ADS relief. Given that there is no historically strong growth location that provides that kind of opportunity its almost irrelevant if you have growth over the next 5-10 years in mind.
Looking Forward with Optimism
In the 1990’s many property millionaires were made when interest rates were as high as 15%. Taking advantage of the weakness in property values, many investors (many who relied on funding) bought quickly.
A friend recently shared with me how in 1989 he had purchased over a million pounds worth of discounted commercial property with expensive commercial lending, only made possible by the fact that he simply needed the portfolio to ‘wash its face’ as he had a stable (albeit not well paid) job. When he poured himself a glass of champagne on hearing that interest rates had been cut from roughly 15% to 14% in 1990, a friend asked what o earth was there to celebrate? His answer was, “because once rates start going down thats likely the beginning of a snowball of multiple rates cuts - and the whole reason I bought at the bottom of the market despite the huge debt costs”. By the beginning of 1993 the UK interest base rate was down to 6% and UK GDP growth averaged out at 3.7% per year in the UK over the next decade.
Nobody is expecting that to happen now (interest rates aren't actually that high no matter how it may feel), but by ensuring you are buying property at a healthy discount, at the best available interest rate, and CRUCIALLY in locations historically proven for growth - or with the right economical contingents for growth - then eventually inflation will fall, the market will recover and the cycle of boom and bust will repeat again and again.
If you have the cash, on the other hand, the world is your oyster.