To answer this question, we must go back to the Summer 2015 Budget. The Chancellor unveiled plans to limit the tax relief that buy-to-let (BTL) landlords could claim on their mortgage interest. This marked the biggest shift in the investment landscape in decades, presenting a significant game-changer for investors.
The original goal, as stated by the Chancellor, was to “create a more level playing field between those buying a home to let and those buying a home to live in” However, it's no surprise that investors delved into the rule book to find effective ways to navigate this change in their favour.
One of the significant adjustments resulting from this change was investors turning their attention to Serviced Accommodation (SA) as a means of mitigating the impact. Airbnb had already gained traction in the UK over the previous years, gaining a strong reputation, along with other start-ups and established digital players like Booking.com. Many investors began transitioning their BTL properties to SA. Not only could they claim their full mortgage interest as a cost, but they also experienced a general increase in rental income. Though managing SA requires more effort compared to traditional BTL properties, for many investors, the increased profitability (and increased ability to deduct costs) made it a worthwhile trade-off.
Another major change following the Summer 2015 Budget was the shift toward using companies as the primary vehicle for holding investments. However, investors had by then discovered the opportunities and potential of SA and never looked back. Recent global events and disruptions worked in the favour of many SA operators, enabling them to cater to locals unable to travel abroad but still seeking a pleasant holiday or getaway.
Additionally, SA operators have tapped into a substantial non-holiday market: contractors working away from home. This proves cost-effective for companies compared to accommodating say 4 staff in a Premier Inn for extended periods. The economic advantages, the homely appeal of having a lounge and kitchen, coupled with the convenience of semi-regular cleaning, make SA an attractive option. Moreover, when contractors return home for the weekend, there's an opportunity to let the unit to leisure guests on a Friday and Saturday night for some extra income.
The flexibility of SA presents further opportunities to enhance profitability. Various websites track demand and supply in specific areas. When supply dwindles, these platforms adjust the nightly rates accordingly (i.e push the price up). Conversely, when supply exceeds demand and there are more units on the market than people looking, they lower the rates to ensure occupancy and that some income is received rather than leaving the unit vacant due to high asking rates. It's a clever approach!
Given the higher management commitment, specialised SA managers have emerged, offering investors a hands-off management approach, akin to the benefits associated with BTL properties. In the early days, investors were typically involved in the entire process, even handling cleaning tasks personally. However, now that service providers have taken over this aspect, these have all been outsourced as an investors' time has become more precious.
A serious investor adopts a portfolio view, seeking diversified income streams as a risk mitigation strategy. Investing in different geographic locations can provide a sensible level of diversification. This approach enables investors to compare areas and business models, focusing their efforts on expanding the most lucrative and successful divisions and leaving the less successful area’s or departments to tick over – or maybe exit altogether! This stands in contrast to investors with a single strategy in a specific geographic area, leaving them without a comparative benchmark and no way of knowing if this is the best return they could be getting.
While considering the benefits of a diversified investment strategy, it's essential to briefly touch upon the challenges traditional investors face: increasing regulations and the pressure to prevent eviction of tenants. The legal system faces delays in dealing with non-paying tenants, and there's a growing emphasis on Energy Performance Certificates (EPCs), landlord licensing, and Housing in Multiple Occupation (HMO) regulations such as Article 4 restrictions. While SA also has its own set of regulations, there's a degree of flexibility, and there are no Assured Shorthold Tenancy (AST) contracts.
Beyond the business case for SA as noted above, it is worth sharing some words of wisdom from the experience in assisting clients in this space. The following accounting and tax-related advice is offered for those contemplating SA investments:
Firstly, a company often proves to be the most suitable vehicle for holding investments. However, it's crucial to discuss this with your accountant, preferably one well-versed in property and SA (See our recommended Accountants at the bottom of this article). Forming the company should be done after securing an offer, and it's advisable not to register the company at your residential address; your accountant's address is a much, much better choice.
Secondly, and the most critical point - factor in VAT.
How do we tackle this? Many investors set their room rate at £100 per night and structure their business model accordingly. However, once your turnover within a 12-month period exceeds £85,000, you must register for VAT. If you increase the rate by £20 per night, prospective guests may opt for a more affordable option down the street at £100 per night, potentially resulting in vacant nights for your property at the higher rate of £120.
As a result and an alternative, you'd be compelled to deduct VAT from the £100 rate, leaving you with £83.33 (and £16.67 for HMRC). Unfortunately, this realisation comes as a surprise to several growing SA investors who only start to seek professional assistance when their business expands. Some continue with VAT registration, while others find the business model unsustainable at £83.33, considering their initial calculations were based on £100. For instance, we have a client who temporarily closes her SA unit to maintain turnover below £85k negatively impacting her property and business valuation. As rates increase over time, the unit remains closed on more nights. Not an ideal situation.
So what's the solution? From the outset, assume you'll receive £83.33, with a £16.67 bonus as a small-scale investor. If your business model remains viable without the bonus, you have a scalable business. If the bonus is crucial for sustainability, halt investments when your total turnover within any 12-month period approaches £60,000. This allows ample room for rate increases, keeping you comfortably below the VAT threshold.
While there's much more to discuss, these are the fundamental, non-negotiable points you should be mindful of. We have spent years recruiting an expert power team, allowing us to offer a hands off, end to end Sourcing and Management service for Serviced Accommodation. For further guidance on tax and general accountancy, please contact our recommended Accountancy specialist:
A final word of wisdom - Your success to a large degree hinges on the team you assemble around you, so strive to gather the best team you can afford to help you achieve your dreams. Happy investing!