Why holiday homes are the new buy to let
Last year saw some nasty, unexpected surprises for the country’s estimated two million landlords. In July, the government announced plans to curb mortgage interest relief for landlords and to scrap the wear and tear allowance, and then in November it announced a 3% stamp duty surcharge for anyone buying a second property.
The changes have left many wondering if property investment is still worthwhile, but there’s one area of the market that has escaped the worst of the changes, and even provides some extra tax benefits – the holiday let market.
It’s little wonder, then, says Michael Wright, director at property accountancy firm RITA 4 Rent, that there has been a surge in interest in investing in holiday lets. “There’s been lots of interest generally about all the different avenues to explore as far as what can be done to mitigate the fact the mortgage interest relief changes will be starting from next year and furnished holiday lets is one area that is growing in popularity,” he says.
How the tax advantage works
Holiday lets are viewed by HMRC as a trade, not an investment, so not only will all mortgage interest costs remain deductible from any income, but there are also capital allowances available that are more generous than the wear-and-tear allowance on buy-to-let properties ever was. Plus, there’s the opportunity to roll over any capital gains – if you sell a holiday let and buy another commercial property, any gain from the first can be deferred until you sell the second.
From a tax perspective, you’ll only be able to make use of the more favourable tax rules above if you purchase a property in the UK or European Economic Area, says Mr Wright. However, if you buy in the UK the 3% stamp duty surcharge applies to holiday let purchases if you own any other property. Outside the UK, the stamp duty rules of the country you’re buying in will come into play, but be aware that while the UK government can’t make you pay the additional stamp duty on the purchase of a property abroad, it can make you pay an extra 3% when you buy your first home in the UK if you already own a property abroad.
But there are strict criteria you need to meet to have a property treated as a holiday let by HMRC and if you don’t, you’ll have to pay tax as if your property is a standard let, regardless of what you use it for, says Mr Wright.
“A lot of people don’t fully understand what makes a property able to be classed as a holiday let,” he says. “There are three conditions that you have to meet. It has to be available for at least 210 days per year, it has to be actually let for at least 105 days and you can’t have any periods of longer-term accommodation — 31 days at a time — that add up to more than 155 days. It is trying to stop people getting around the system by renting it out more like a standard buy to let but calling it a holiday let.”
Good little earners
Tax changes may have provided the recent impetus, but some landlords recognised the potential of holiday lets long before this. Vanessa Warwick, a Guildford-based landlord and founder of landlord property forum PropertyTribes, is among them. She bought her first holiday let property in Camber Sands in East Sussex eight years ago and also owns another on the Isle of Portland in Dorset.
“We decided to get into holiday lets because we’d already established quite a significant portfolio of single occupancy buy-to-lets and we felt it was a good time to diversify away from that to mitigate risk. We also predicted that the Great British seaside holiday would come back into vogue and that holiday lets would be a growing area,” she says.
“Typically, whatever rent you can get for a single occupancy property for one month, you can get the same amount for a holiday property for one week, so if you get your occupancy levels very high you can certainly deliver a very nice cash flow.”
But Ms Warwick says it takes more money to set up a holiday let and longer for it to become established than a standard residential property. “Many standard buy to lets are unfurnished, but with holiday lets you have to buy everything down to the last teaspoon.
“Initially, it can take a while to get traction in the marketplace because people are looking for things like TripAdvisor ratings. But over time our occupancy has improved. We are pretty much fully booked from May to October, and then we get Christmas and New Year and bank holiday bookings as well.”
Brian Sceats, who worked in financial services marketing before retiring, bought his first holiday let in Marbella, in southern Spain, before purchasing properties in Antigua and Yorkshire.
“Initially we bought them as holiday places for us to visit, but because we didn’t have time to use them as much as we ought to we decided to utilise the assets and start renting them out,” he says. Brian has previously owned buy-to-let properties and student lets, but decided to sell his other properties several years ago.
“You hear all sorts of horror stories on television at the moment – you get people not paying the rent, trashing properties and using the law to try to get out of it. We did have some problem tenants with students lets so that’s why we decided to get out of that. With holiday lets you always get the money upfront and while there is more work to do, the yield is generally higher.”
Best ways to boost your bookings
To increase your chances of getting year-round bookings, Ms Warwick advises choosing an area with weekend break potential. “My advice would be to buy somewhere within a one-and-a-half hour drive of a major city so you get the long weekenders market, meaning people can be on the patio drinking a glass of wine within an hour and a half of leaving the office.”
Adam Walsh, commercial manager at Interhome, a holiday let property platform, has similar advice. “Most holiday destinations are quite seasonal – that may well suit an investor because when it is empty they may plan to use the property. But somebody who wants to buy a holiday property as a pure investment should choose an area where business is year-round. I would recommend somewhere like the south of Spain, where the temperature means there is year-round business, or the Canaries, which are also doing very well.”
To get the best yields, it’s vital for owners to make sure they cater to holidaymakers, not their own needs. “You can’t get too personally involved in the property,” says Mr Walsh. “You have to design the inside and kit it out as a mini hotel as opposed to a family home. If you want to live there yourselves in a few years, you can kit it out as a home then, but for now you need to think of holidaymakers.”
How to fund your holiday let
You’ll need a similar level of deposit, about 25%, to buy a holiday property as you would a standard buy to let, but the number of lenders offering holiday let mortgages is smaller and other requirements can be more stringent, says Simon Collins, product technical manager at mortgage broker John Charcol. “The rental calculation does tend to be higher.”
He says that an average debt-service coverage ratio (which shows the proportion of income to the cost of servicing the mortgage debt) for a holiday let will probably be about 130%. The mortgage debt used for the calculation is based upon standard variable rate plus 1%.
“There are not a huge amount of lenders doing holiday lets, but there are a reasonable amount,” he says. “There are none of the really big names – probably about the biggest name in holiday lets is Leeds Building Society.”
Leeds’ product offers specially designed mortgages for holiday homes in England, Scotland and Wales.
Another complicating factor for those planning to use their holiday property themselves is that many holiday let mortgages don’t actually allow owners to stay in the properties. Market Harborough Building Society, however, has a ‘second home’ mortgage that lets owners stay in the property themselves and rent it out for up to 24 weeks a year.
Can you turn your buy to let into a holiday let?
With the tax advantages of holiday lets becoming increasingly clear and the popularity of websites such as Airbnb seeing more tourists opting to stay in apartments rather than hotels while visiting city centres, some landlords have been toying with the idea of converting a rented property into a holiday let.
But it may not be easy to change your mortgage, says Mr Collins. “Lenders will be a bit wary if somebody is trying to claim a one-bedroom flat in Peckham is a holiday let.”
There are other hurdles if you own a flat, as your lease may prohibit any form of letting other than assured shorthold tenancies. And particularly in London, some councils require planning permission to change the use of a property permanently to a holiday let.
But there are circumstances where changing the use could work, says Mr Wright. “Somewhere like Edinburgh, where there are lots of tourist attractions, there could potentially be a holiday let market there.”
Whether you’re considering purchasing a holiday let or changing an existing property into one, it’s vital to do your homework on the area, the demand and the competition. And since it could be argued a few short breaks are the best way to research this, you may well find that due diligence suddenly seems a lot more appealing than it has for other investments.
How to market your holiday let
Once you’ve found a property, you’ll need to decide how you’ll rent it out. You could set up your own website and self-manage your property, use an agency, or use a platform for holiday let owners, such as HomeAway or Airbnb.
Airbnb charges a 3% commission, while HomeAway charges 8%. Both also charge fees to guests, however, so this could limit the amount you’re able to charge.
If you’d prefer to use an agency, there are lots of companies that will take over management of your property for a commission of about 20% to 30%. While that may sound steep compared to the DIY options, many holiday let owners feel they couldn’t achieve the same level of bookings without agencies.
“If you find the right agent, they are worth their weight in gold,” says Adam Walsh. “Unless you are living within five minutes of your property I would think you would have to have it fully managed. Ours are a long way from us, so it would be unrealistic for us to manage those properties.”
Brian Sceats agrees but says outside the UK, good agencies can be harder to find, which is one reason he has leased his Antigua property back to the company he bought it from in a guaranteed rent deal. For his Yorkshire property he uses agency Sykes Cottages, which typically charges owners a commission of about 20% of each booking, but in Spain he hasn’t been able to find an agency he’s confident can gather the same level of bookings.
“One of the benefits of using an agency is that you haven’t got the hassle of dealing with enquiries and people phoning up and saying ‘what’s your best price, can you reduce it?’ as they tend to do with the Spanish one,” he says. “If there was an option for me to use something like Sykes in Marbella I would do it, but while there are lots of little companies out there that say they can do the same thing, they haven’t got the internet presence, which is really important now. So we do a combination of things: we have our own website, which we don’t get much through, we use TripAdvisor, which does get some enquiries because it is a massive company, and we are also registered with a couple of small local companies over there as well.”
Adam Walsh says the multi-pronged approach is the best way to get good returns from a holiday let: “Choose a diverse number of channels to distribute. A lot of owners will just go with one local agent and one big platform, whereas it is better to try to diversify that exposure and get as many different ones going even though you may only want to fill 13 weeks a year. A local agency will be very focused on the local market and you want people coming from as many different areas as possible.”
The general term for the rate of income from an investment expressed as an annual percentage and based on its current market value. For example, if a corporate bond or gilt originally sold at £100 par value with a coupon of 10% is bought for £100 then the coupon and the yield are the same at 10%, or £10. But if an investor buys the bond for £125, its coupon is still 10% (or £10) and the investor receives £10 but as the investor bought the bond for £125 (not £100) the yield on the investment is 8%.
A hugely unpopular tax paid on property and share purchases. Stamp duty on property is levied at 1% for purchases over £125,000 (£250,000 for first-time buyers) which then moves up at a tiered rate. For property between £125k and £250k you pay 1%, then 3% from £250k up to £500k and then 4% from £500k to £1m and then 5% for properties over £1m. But unlike income tax, which is “tiered” and different rates kick in at different levels, stamp duty is a “slab” tax where you pay the rate on the whole purchase price of the property. On shares, stamp duty is charged at a flat rate of 0.5% on all share purchases. Figures correct as of May 2011.
The catch-all term applied to investors who buy properties with the sole intention of letting them to tenants rather than living in them themselves, with the proceeds from the let usually used for the repayment of the mortgage. Buy-to-let investors have to take out specialised mortgages that carry higher interest rates and require a much bigger deposit than a standard mortgage. Other expenditure can include legal fees, income tax (on the rental profits you make), capital gains tax (if you sell the property) and “void” periods when the property is unlet.
This is a mutual organisation owned by its members and not by shareholders. These societies offer a range of financial services but have historically concentrated on taking deposits from savers and lending the money to borrowers as mortgages, hence the name. In the mid-1990s many societies “demutualised” and became banks. One academic study (Heffernan, 2003) found demutualised societies’ pricing on deposits and mortgages was more favourable to shareholders than to customers, with the remaining mutual building societies offering consistently better rates. In 1900, there were 2,286 building societies in the UK; in 2011, there are just 51.