How to make 25k tax free a year

I’m fascinated by ‘financial engineering’ and how every so often, quirks of timing cause financial opportunities to present themselves. An alignment of the ‘financial stars’ can scream out – this investment is too good to be true!

Buy-to-let boom in the 90s

I remember in nineties, running my slide rule over the gross rental yields and BTL mortgage costs and thinking – with gross yields at over 10% and income multiples for purchasing a property at historic lows; the whole residential sector was screaming – buy, buy buy!!!

It was clear, I would be in line for phenomenal returns on my cash invested over the next 10 years.

History shows, I was right. If you could get your hands on buy-to-let finance then it was a one way street….and I bought as much as I could with my limited purse and finance options.

Current property investing opportunities

I’m always attuned to the relative opportunities, costs and value of money and property, and it seems that we have reached one of those infrequent alignments of the ‘financial stars’.

Some interesting numbers indicate that I can make £25,000 a year by NOT renting out my latest purchase – the penthouse apartment in Nottingham.

To make this money without any tenant seems crazy. It’s completely against the Property Hawk philosophy I’ve touted over the last 10 years – ie, maximising your rental returns.

However, I’ve got to the stage in my life where having somewhere nice to live and not income maximisation is my perogative. I can make a pretty penny and still have a nice place to stay. Am I going soft in my old age? Views from seasoned Hawkers are invited.

Enough of the blurb, here are the figures that explain how I will make £25,000 a year, (give or take a penny) tax free from owning and occupying my new apartment.

How I will make £25,000 a year from the penthouse apartment without renting it out.

Firstly, I’m aiming to make over 25% on the initial development and refurbishment of the apartment. So the purchase and development, which will cost me no more than £190,000 should yield up an apartment comfortably valued at £250,000 but this is not just how I propose to make the £60,000 tax free over 5 years – so read on.

Stage 1 – Remortgage of investment

• Value of property : £250,000
• Deposit : £50,000 (25% LTV)
• Mortgage : £200,000

Following completion of the redevelopment of the apartment I am going to obtain a buy-to-let mortgage on the property.

Currently going through Property Hawk Mortgages it is possible to obtain a 5 year fixed rate BTL mortgage with the Newcastle BS with a pay rate of 3.89%. On a £200,000 mortgage the monthly repayment works out at £1044 per month, lets say for ease we will call it a grand a month, so £1000 or £12,000 per anum.

Stage 2 – Leveraged investment in VCTs

For those not in the know, Venture Capital Trusts (VCTs) are a little income gold mine. I’ve been investing in them since 2004 and have taken a high yield tax-free income from them during that time.

Like all equity investments there is risk involved and no absolute guarantee of a dividend. Having said that, if you choose the right VCT, then the income is highly reliable. So the up shot is that my intention is to stick the cash I take out of my property investment into a small selection of VCTs. The current VCT tax rules are – you can invest a maximum of £200,000 in VCT per annum to benefit from the initial 30% tax deduction.

As far as I am aware, there are no limit to investments for 2nd hand VCT shares.

There are a number of existing opportunities to invest in VCT shares yielding between 7-8% excluding any initial tax benefits. So lets just say, that on the £200,000 I have borrowed against my penthouse property investment, I achieve an 8% net yield. This would generate an annual income of £16,000, excluding any personal tax benefits on the initial investment.

• VCT investment : £200,000
• Net income per anum : £16,000

The result annually for me is that there is a surplus of :

• Mortgage payments: -£12,000
• Income from VCTs: £16,000
• Net income : £4,000
• Service charge for penthouse apartment : -£4,000

• Balance on loan & income account per annum : £0

The power of the repayment mortgage

Taking the income annually and mortgage costs along with the service charge, I should be in balance, so in this respect there are no costs to owning my penthouse property.

However, it’s easy to forget that the cost of the mortgage is for a repayment mortgage – and according to my mortgage calculator at the 3.89% fixed mortgage cost, after 5 years, I will have repaid just over £26,000 off from the original £200,000, leaving just £173,689 left on the mortgage.

So let’s be generous and say that it has reduced my loan by £25,000 or £5,000 per annum.

• Reduction in mortgage loan (5 years) : £26,311
• Approximate annual reduction : £5,000

Immediately, you can see that without any change in capital values on my penthouse apartment, or any tax benefits from the initial investment in VCTs, I’m making £5,000 a year out of just owning it without even renting it out.

Expected capital appreciation

Now, the following is pure speculation – nobody know what is going to happen to the capital value of property over the next few years, but taking 2.9% as my annual capital growth (taken from Nationwide Building Society long-term trend line), and assuming the property follows this trend line – extrapolating the capital value, at the end of year 5, the apartment will be worth £288,425.

This equates to a capital appreciation of £7,685 per annum.

• Projected capital growth rate : 2.9%
• Original capital value : £250,000
• Value at end of 5 years : £288,425
• Annual increase in value : £7,685

Total tax-free annual return

The total tax-free annual return from not letting out and just owning my penthouse investment for the next 5 years stands at:

• Repayment amount on mortgage per year : £5,000
• Annual increase in value : £7,685
• Total annual change in value : £12,685
• Monthly increase in capital over the year : £1,000

Rental value of my penthouse

I have already indicated that I am not interested in letting this property. Why would I let the marauding tenant classes into my luxury apartment. However, should I become desperate for the income I know that this penthouse would easily let for £1000 + per month. Therefore, potentially this would generate another £12,000 gross per year. The fly in the ointment here is the proposed loss of BTL mortgage interest relief, and another reason why I’m not so desperate to rent out the apartment.

Development profit

The other element of project penthouse is the potential initial development project. I have already said that this not unreasonably could approach £60,000. If this is apportioned over a 5 year period it works out at £12,000 per annum or £1,000 per month.

Total projected returns on my penthouse property

Therefore, the projected returns on my penthouse investment could run up to a gross of £3,000 per month or £36,000 a year over the next 5 years if I did decide to rent it out; or £2,000 per month without the complications of having a tenant.

The risk factors

There are as always a number of risk factors that may affect the projected returns; the main ones are as follows:

• Removal of some or all of the VCT tax advantages
• The penthouse apartment fails to value up to the projected value
• Cost over runs on the development stage
• Dividend payments do not meet expected levels
• House prices fail to grow at the expected rate or even fall

Clearly, nothing is without risk but in the current volatile investment market with only very low guaranteed returns a penthouse pad doesn’t seem a bad option to stick my money in.

Am I going soft in my old age, or am I just deluded?

Thoughts, comments, observations – please post them below.

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