2 Jun 2016
Author: Stephen Breen
A number of changes to regulation coupled with soaring house prices have made buying an investment property for your student children a less attractive prospect.
Historically, helping your children out with student accommodation has meant good returns. The property can be rented to a number of students, subsidising the purchase – and when it is no longer required, it can be sold for a profit. If you had purchased a student property four years ago in York, you’d be looking at a 25 percent uplift if you sold your investment now, according to Hunters Estate Agency.
However, rising property prices and new rules impacting the costs involved in buying a second home have changed this.
A report published by Savills last week looked at the cost of purchasing a two-bed flat versus renting a room in a comparable property across the top 50 university cities and towns in the UK. Even after factoring in the rent you can charge for letting out the flat, renting works out cheaper than buying for 28 of the 50 locations. With tax relief on interest payments due to be tapered between April 2017 and 2020, it is likely that renting will become cheaper than buying in even more of the locations.
Not all locations have been affected by the steep rise in prices, however – where there is still a shortage of accommodation, like in Manchester City Centre, prices are still climbing, offering some investment potential. Ascend Estate Agency predict that prices in the City could rise by 8 to 10 percent a year before levelling off at 4 or 5 per cent.
Entry costs – renting vs buying
Renting a property can be an expensive business with a range of costs up front: typically a deposit equivalent to a month’s rent, a further month’s rent in advance and estate agency fees which average £386.
This may seem steep, but the cost to purchase a buy-to-let property is far higher. Typically a 20% deposit will be required plus stamp duty which has been increased by 3% on second homes since April of this year. On a £250,000 property, stamp duty used to be £2,500 – now, for buy-to-let properties (which are classed as a second home), a fee of £10,000 would be payable.
Entry costs are still affordable for some locations in the UK, including Coventry, Durham, Dundee, Leicester, Stirling, Loughborough, Sheffield, Liverpool, Lancaster, Strathclyde and Glasgow. Properties in this area will require £30,000 or less up front (deposit and stamp duty).
Running costs – renting vs buying
The running costs for students renting a property are reasonably low – their rent may or may not include bills and aside from this, the landlord will decorate the accommodation and pay for any repairs.
By contrast, those buying a property will usually spend up to £4,000 furnishing it, according to Santander. Owners then are responsible for any property maintenance repairs which the Halifax suggests average at £1,100 a year. Additionally landlords must pay for insurance and agents’ fees and will need to cover the cost of the mortgage during any period where the property is vacant.
Changes set to squeeze profits
At the moment, landlords can claim tax relief on mortgage interest against the rent they receive. However, the rules are changing from 2017, and this tax relief will be tapered away to a 20% flat rate tax relief from 2020 onwards. This is likely to affect higher rate tax payers the most.
It’s also possible that mortgage interest rates may rise over the next few years, squeezing profits even further.
How you can help your child
One option to help mitigate the rising costs is to purchase the property in your child’s name. As an owner occupier of their first property, they won’t be liable for the 3% higher stamp duty rate. The Government’s rent a room scheme also allows them to rent out spare rooms tax free for up to £7,500 a year. However, if the purchase is an all-out gift, you must survive for seven years to avoid any inheritance tax implications. If the purchase is a loan, you cannot be named on the property deeds or the 3% stamp duty hike will still be payable. You should also be aware that capital gains tax may be payable if you loan the money with interest and the value of the property increases.
An alternative way to help your child without putting the property in their name is to set up a trust, loaning the trust the deposit for the property and take out the mortgage in the trust’s name. Your child will be a ‘life tenant’ of the trust, allowing them to live in the property rent-free. As a beneficiary of the trust, it is their own ‘principle private residence relief’ which becomes relevant for the time that they are in the property. When they no longer need the property, you have 18 months to sell it as trustee and claim exemption for the whole period of ownership provided that your child has occupied the property at all times. During the 18 month period you can continue to let out the property without the Capital Gains exemption being affected. There is no cap on the amount of gains you can take free from tax under this arrangement, and your private residence relief on your own home remains unaffected.