Holiday Lets

Today’s post is about possibly the last remaining way to make decent returns on property – holiday lets.

Property

Property is a funny asset class.

• We seem to be obsessed with owning it here in the UK (though millennials are finding that hard to put in practice, and so may fall out of love with it).

People think that property is safe and that it produces better returns than stocks.

• Property prices are “sticky” since people don’t like to sell for less than they paid to buy (they have the same attitude to stocks, but their prices are more fluid).
• Lots of people are too young to remember the last real crash, in the early 1990s.

And returns are inflated by gearing of 80% to 95% (mortgages).

• I can only imagine the reaction of the same people if I asked them to borrow 90% of the money that they planned to put into the stock market.

Don’t get me wrong – owning your own home is a good idea.

• It’s effectively a prepayment of your shelter costs for the future.

This reduces your sequencing risk in retirement, making it less likely that you will run out of money.

And of course, your primary residence is sheltered from capital gains tax.

• Since it will probably become your largest single capital gain over time, this is a big deal.

Buy to let

For the last two decades, the other good option was buy-to-let (BTL).

• Prices were low, which meant that rental yields were high.
• And as prices rose, you got capital appreciation as well (albeit subject to CGT).

But now prices are so high that yields are not useful.

• In my street, they are around 3% gross (before costs, fees and voids).

Even worse, the government seems determined to drive the small-scale BTL investor out of business.

• They added an extra 3% of stamp duty to the already astronomical transaction charges on second properties.

The previously generous “wear and tear allowance” has been replaced by a more stingy “replacement allowance”.

• And BTLs attract a higher rate of CGT (28% rather than 10%).

HMRC are also phasing out the ability to offset mortgage interest against gross rental income.

• Since 2020/21 this offset has been limited to basic rate relief.

For leveraged landlords, this means a much bigger tax bill.

• Those who can afford to repay their loans will lose flexibility in taking the income.

Commercial property (via REITS) is the natural alternative, but with the death of the high street (accelerated by Covid), it faces its own headwinds.

• Can holiday lets come to the rescue?

Holiday lets

The basic point about holiday lets is that they are treated as a business rather than an investment.

Here are the rules that must be satisfied – within each tax year, or during the first/last 12 months of ownership – for a property to qualify as a Furnished Holiday Let (FHL):

1. It must be furnished.
2. It must be in the UK or the EEA
   • Sadly, the Isle of Man and the Channel Islands don’t count as the UK here.
   • If you have multiple properties, UK and foreign ones are grouped separately (we’ll look at foreign holiday lets in detail below).
3. It has to be available to the public for 30 weeks / 210 days / 7 months per year.
4. It has to be actually let for 15 weeks (105 days).
   • With multiple properties, you can use an averaging rule to meet this requirement.
   • You can also use a “period of grace” for up to two years after a successful FHL year.
5. No single let should be for longer than 31 days.
   • There is scope for up to 155 days of “longer lets” per year, but these don’t count towards the 105 days of shorter lets.
6. The business must be operated on a commercial basis, with a view to making a profit (and with market rents).
   • It’s fine to let the place out at a lower rent in the offseason to cover costs.

Income tax

The key income tax advantage is that the BTL mortgage interest rate restriction doesn’t apply.

• Note that the additional 3% Stamp Duty does still apply.

The other thing to note is that profits from FHL’s are treated as Earned Income, and so can be offset by pension contributions.

• FHL earnings don’t attract NIC contributions.

Losses can also be offset against other income in theory, but in practice, this is not available for simple self-catering accommodation (as opposed to say a B&B).

• Losses from one FHL can be offset against profits from another one.
• But UK losses won’t offset EEA gains, nor vice versa.

There are also Capital Allowances for buying  items “embedded” in the property (lighting, air conditioning, fixtures and fittings).

And profits can be allocated flexibly between joint owners.

Capital gains tax

FHLs can also qualify for Gift Relief, which allows them to be passed on to the next generation without triggering a disposal for CGT purposes.

FHLs also qualify for Entrepreneur’s Relief, which means CGT at 10% on the first £1M.

• Total gains will be apportioned to the period where the property qualified as an FHL.

CGT can be deferred if the money from a sale is reinvested in another FHL property.

• And if a property is given away, the gain can be “held over” until the recipient sells.

CGT losses will be offset against the next available CGT gains.

As with inheritance tax, HMRC may challenge reliefs for businesses that don’t provide a sufficient level of service (see next section for more detail).

Inheritance tax

FHL properties can qualify for IHT relief under BPR, but this is not straightforward.

• You need to show that you are providing substantial additional services over and above the normal active management of the property.
• This could mean ongoing assistance with the holiday experience, booking restaurants and activities and providing advice on things to do in the area.
• The closer you can come to the services provided by a hotel, the better.

Which in turns means that you (or your staff) would probably need to be based in the area.

Higher yields

Apart from the tax advantages, the other reason to consider holiday lets is the higher yield.

• Yields vary by region, but are highest in the least desirable areas of the country.

Which found that Northumberland and Wales had yields above 11% pa.

• But down on the South Coast where I would be looking, they are “only” 5.9%

That could still translate into net profits (after fees) of 4.7%, and post-tax returns of 3.8%.

• After inflation, that’s lower than our target SWR of 3.25%.
• But capital gains on the property should track inflation in the long term.

And with current low borrowing rates, leverage could juice these up both yields and capital gains.

Free Holidays

The third reason to want a Holiday Let property is the prospect of free holidays.

• Seven months of public availability still leaves five months for you.

Just remember that it will mostly be during the off-peak season.

Home or away

As noted above, properties in the EEA qualify for FHL treatment. (( Even post-Brexit this remains the case, for the time being at least ))

There are a couple of things to think about if buying abroad:

1. Purchase costs are usually much higher
2. And there are lots of ongoing deductions too.
   • For example, in Portugal, you lose 20% in agency fees, 6% in VAT, 10% in stamp duty and 28% in income tax – that’s 64% in total.

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That’s it for today.

• I hope I’ve persuaded you that Holiday Lets are an interesting proposition.

As always, the devil is in the detail, and you’ll need to do your own research in the area of the UK where you plan to invest.

• I might look into Cornwall over the next six months, and if I find anything interesting, I’ll be back with another post.

Until next time.