Mortgage interest rate rises coupled with Section 24 tax changes have meant that many homes that were once available for rent have been removed from the market. Section 24 has been disastrous for both tenants and landlords and the government’s plan has spectacularly backfired. This has been mainstream news for several months now, but rather than selling up, is switching to short term lets a viable option for landlords?
In 2015, the UK government introduced a restriction on tax relief on buy-to-let mortgages, known as Section 24. Since the introduction of Section 24, landlords can claim back mortgage interest costs but only up to the basic income tax rate of 20%. The changes were phased in from 2017 but came into full effect in April 2020.
Prior to the introduction of Section 24, landlords could deduct all of their mortgage interest from their rental income and pay tax solely on their profits.
Section 24 changes have been introduced in tandem with several other changes impacting private landlords, including:
The net result of these changes has been an increase in costs for landlords impacting the profitability of their investments.
In addition to changes already introduced, landlords also face future cost increases and uncertainty, with the government planning the introduction of additional rules which will impact landlords, including:
As landlords face increasing costs and taxes there is also a growing anti-landlord rhetoric in the United Kingdom. With landlords increasingly being portrayed as ‘parasites’ who provide little value to the economy. The reality is they provide a critical role in the economy.
Whilst the impact of Section 24 is material, their impact until recently has been relatively benign. Because interest rates were so low the impact of Section 24 had not been significant for many landlords. However, rapid increases in mortgage interest rates mean that many private landlords are now feeling the pinch.
To highlight the impact of Section 24, I have analysed a property located in a commuter town on the M25 and shown the impact of a significant increase in mortgage rates (as if it was owned by a higher rate taxpayer). The property is a real property and was completed in 2021 during the Covid pandemic, the developer was unable to sell all of the apartments and has let some of them both in the short-term rental market and private rental market.
Summary
Assuming the property is mortgaged on an interest only mortgage at 2.5% p.a. then the financials would broadly be the following.
| Gross Rental Income | £10,200 p.a. |
| Service Charge | £810 p.a. |
| Property Management (AST) | £1,020 p.a. |
| Mortgage Interest | £5,300 p.a. |
| Net Income | £3,070 p.a. |
| Tax Payable | £2,288 |
| Net Profit After Tax | £782 |
If the mortgage for the same property increases to 6% p.a. the annual mortgage cost will increase from £5,300 p.a. to more than double at £12,720 p.a. The impact of the change in mortgage interest would mean that the landlord both suffered a loss but also had to pay tax on the loss.
| Gross Rental Income | £10,200 p.a. |
| Service Charge | £810 p.a. |
| Property Management | £1,020 p.a. |
| Mortgage Interest | £12,720 p.a. |
| Net Loss | -£4,350 p.a. |
| Tax Payable | £804 |
| Total Loss After Tax | -£5,154 |
Faced with such high financial losses some landlords will choose to simply sell up and leave the market altogether. However, in the face of both a slow market as well as the potential of a financial loss to sell their property many landlords will simply choose to remove their property from the long-term rental market and put it on Airbnb.
For those landlords who own property in their own name and therefore subject to Section 24 rules, there are significant financial advantages to converting from the private rental market to the short-let market. Principally, because holiday lets are not subject to Section 24 tax rules. In addition, short lets typically rent at much higher rates so even though management costs are higher, most landlords will be far better off.
The developer has also let an identical apartment on the ground floor adjacent to the property on a short-let basis at an average rate of £97 per night (after fees). The property is in a popular town and is occupied for approximately 65% of the year.
So for the same high rate taxpayer the financials would be as follows:
| Gross Rental Income | £23,013 p.a. |
| Service Charge | £810 p.a. |
| Property Management | £3,500 p.a. |
| Mortgage Interest | £12,720 p.a. |
| Net Income | £5,983 p.a. |
| Tax Payable | £2,393 |
| Net Profit After Tax | £3,590 |
Switching to short let will not be possible or workable for many landlords, as there are a number of issues which landlords will need to consider.
Many local councils have rules preventing or restricting landlords from letting property out in the holiday rental market, these may prevent an owner from letting a property in the short-term market. Or they may require a landlord to obtain planning permission to let for more than 90 days, say for example in London.
However, some financially stressed landlords may simply risk letting the property outside of the rules or alternatively to focus purely on the high-cost nights across the year and keep the property vacant for the remainder of the time. This may well be viable in locations which have very high rates for periods of time for example Wimbledon or alternatively in prime holiday locations.
In the example I have given, the breakeven point is circa 45% occupancy. However, it is likely that a landlord could reduce to say a 90 day maximum by focusing on prime nights such as weekends and limiting management costs.
Many mortgage providers require landlords to obtain permission to let a property in the short-let market. This may not be forth coming in some situations. However, just like some landlords do not obtain permission to let a property on an AST there will likely be an element of landlords who simply take the risk. Assuming that the bank simply wants the mortgage paid.
It may be more challenging for landlords in properties which are held in a leasehold, in many situations the lease will prevent short lets. However, in the example I have given, the lease prevents short lets but the head lessor (developer) was prepared to waive this restriction for an incoming purchaser.
Landlords will also need to consider the time required to manage a short-let property; it is far more time consuming. In addition, management costs are likely to be significantly higher.
It appears that the government’s policies on trying to force small landlords from the rental market is backfiring spectacularly. Where landlords cannot pass all or a substantial part of their increase in costs on to tenants, they simply decide to remove their property from the private rental market. However, instead of selling their rental they may simply decide to let it in the short-let market.
If landlords do decide to switch to holiday lets, it will put even greater pressure on rents and availability of rental stock. There is some evidence that landlords are already making the switch. From the initial research we have done the total number of properties for let on Airbnb has skyrocketed from 243,599 listings in January 2018 to 437,321 listings in July 2023. Good news if you’re a tourist, not such good if you’re looking for a home for yourself and your family. And for landlords? It could be a viable option if you’re looking for long term capital appreciation and don’t want to sell up.
At MyPropTech we are currently preparing a detailed analysis of the Airbnb market in the UK to show the impact of government policy on both the short-term letting market as well as the AST market. If you would like to receive a copy of our analysis, please sign up to our mailing list.