From buy-to-let to saved from neglect: a lifeline for landlords

As the rental market stagnates, another door opens, with new tax incentives for investors to renovate derelict homes. Laura Howard reports

Dinner party conversations about bumper buy-to-let returns have given way in recent months to grumbles from landlords that they're getting their fingers burnt much to the quiet satisfaction, no doubt, of those who chose not to take the gamble.

For those who did, the past year has not been easy. While rents have been increasing roughly in line with inflation (currently 4.2 per cent), mortgage costs have run ahead, with the Bank of England base rate climbing from 4.5 to 5.75 per cent since August last year.

Then there is the effect of the credit crunch, which has helped stop the housing market dead in its tracks.

And the type of property worst hit by dwindling prices? Flats where supply runs ahead of demand such as those on new developments that were snapped up by landlords a few years ago.

Repossessions among buy-to-let landlords rose 20 per cent between the second and third quarter of this year and things are set to get worse in 2008, according to the Council of Mortgage Lenders.

But there is a tiny chink of light for those willing to renovate to let to take empty properties and make them into homes that can turn a rental profit.

In his pre-Budget report, Chancellor Alistair Darling announced a change in the VAT rules designed to provide incentives for landlords to take on derelict properties and hopefully breathe new life into rundown areas.

From 1 January 2008, a reduced rate of VAT will apply 5 per cent, opposed to 17.5 per cent on the cost of materials and labour when renovating a home that has been empty for two years. The current law stipulates that homes must have stood vacant for three years to qualify for the reduction.

According to charity The Empty Homes Agency, this will push a lot more of the country's 680,412 vacant properties into qualifying for the tax break.

But that's still not enough, says the EHA's chief executive, David Ireland. "Currently there is no VAT on the cost of building new homes, and we would like to see a level playing field. If the Government is not going to opt for harmonisation, one year standing empty would be preferable."

The change in rules, which has largely fallen under the radar, may not be a "make or break" factor when considering whether to enter the buy-to-let market, but it could bring the idea of renovating an empty home to more people's attention, says Mike Block, head of VAT at London-based accountancy firm The Fisher Organisation and not just commercial developers. "You don't need to be VAT-registered to qualify for the reduction, which means you don't have to be running a business," he explains.

But Andrew Montlake, partner at mortgage broker Cobalt Capital, argues that a private individual looking to regenerate a home and benefit from the new tax law could run into problems. "The average buy-to-let lender will require a rental valuation for a loan, but an empty, derelict property won't have one," he says. "This means that an investor may have to look at a bridging loan until the time that the property is marketable."

Bridging loans typically available at up to 85 per cent of the value of a property for around six months are not cheap. Interest is charged at between 1 and 3 per cent of the balance each month and investors are still left to fund the cost of the work from their own pocket. "However, if you get your figures right, the increased value of the property could make this worth while," says Mr Montlake.

The alternative is to take out a semi-commercial mortgage which starts out as a bridging loan and then morphs into a buy-to-let mortgage when the property is rented out. But whether it is worth opting for this type of finance will depend on your experience, budget and the project size.

Would-be investors will also be restricted in the location of their project, says David Smith, senior partner at estate agent Dreweatt Neate. "We have 13 branches in the area from Somerset to Berkshire and these regions do not have the kind of housing stock that has been empty even for two years."

Areas with large numbers of empty homes include the north-west of England and, surprisingly, given the high prices for bricks and mortar, London.

But any incentive that encourages a private individual or company to invest in derelict homes is a good thing, stresses Mr Smith. "A VAT reduction from 17.5 to 5 per cent is a real bonus as it's basically adding a 12.5 per cent profit to an investor's bottom line.

"For example, on a capital project of 250,000, a saving of 31,250 can be pocketed."

If you can find the right property and location, and can fund the renovation, further upcoming tax changes may provide an additional boost. From next April, for example, it is proposed capital gains tax will be charged at a flat rate of 18 per cent, down from a top level of 40 per cent.

In addition, following the Chancellor's decision to double the inheritance tax threshold from 300,000 to 600,000 for married couples or those in a civil partnerships, your family will have more to gain from a second home as well.

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