A key choice for investors has been whether to opt for equities (company shares) or for property (buy-to-let).
I recently read an article entitled “Where should you invest for the best returns: Isa, pension or property? Use our calculator to find out” (Paywall). It asked whether you should invest your money in a pension, an ISA, or a property.
I tried the calculator and selected an investment of £100,000 over 30 years for a higher (40%) rate tax payer. The calculated results shown were pension (after 25% tax-free cash taken and with the remainder taxed at 20%) £583,119, ISA £411,614, and Buy-to-let (after CGT) £465,868. For a standard rate tax payer the results were pension £437,339, ISA £411,614, Buy-to-let £562,634. These six results show a compound annual growth rate between 4.83% and 6.05%.
The calculator is something of a “black box” in that you can’t see all the workings used, but some of the assumptions used were: Mortgage interest rate 3%, Housing deposit 30%, interest only mortgage, annual property price growth 1.5%, Annual pensions/ISA interest 5%, Rental yield 5%. Playing around with some of these assumptions showed that a Buy-to-let without a mortgage resulted in only £261,059 for a higher rate tax payer, or £307,340 for a standard rate tax payer. Adding in an assumption of no property price growth resulted in only £198,646 for a higher rate tax payer, or £232,556 for a standard rate tax payer. These four results show a compound annual growth rate between 2.31% and 3.81%. I estimate that the gross rental yield of 5% is reduced by about 25% to a net rental yield of around 3.75% within the “black box.” This is before tax and with no mortgage costs.
It strikes me that unless you believe that from now on property prices will increase faster than inflation, then property investment is not so appealing. Also, a net yield of around 3.75% suggests to me that property may be over-valued, unless you believe that from now on rents will increase faster than inflation.
A UK Buy-to-let yield map shows that the best gross yields (top 25) are above 6.99% and the worst (bottom 10) are below 2.28%.
Estate agent Knight Frank’s guide shows net yields of between 3.50% and 5.25% after operating costs. They don’t provide a definition of operating costs. I suspect they include agent’s costs but exclude repair costs. The annual yield would also be lowered by any months where the property was empty (voids).
Some bloggers have chosen to share their results in using Buy-to-let.
Life after the daily grind has one property, I assume to be in London, and has a net income goal of £19,000 per annum by 2022. That is a net yield of 3.65% on a property valued at £520,000. The gross rental income is £22,000 (4.23% gross yield) and he is aiming to reduce costs from about 25% of the rent to below 15% by not using a property management company and thereby saving over £2,000.
Our Tour have three properties and a shop and in 2016 they had a gross rental income of £22,460 (5.62% gross yield) and costs of £6,498 (29% of rent), resulting in a net income of £15,962 (3.99% net yield).
I retired young has a portfolio of eleven properties in England and in 2017/18 they had a gross rental income of £89,914 (5.30% gross yield) and costs of £21,876 (24% of rent), resulting in a net income of £68,038 (4.01% net yield).
These bloggers are diversified (or not) over one, four or eleven properties. To what extent their investment is passive, and how much time it requires from them, will also vary. Any major problems with tenants, voids or repairs would likely reduce these returns.
In a draw-down situation where you are living off your portfolio income, I favor equities over property. My portfolio income yield has been between 3.82% and 4.84% in recent years. I consider my investment trust portfolio to be quite well diversified across hundreds of underlying companies, bonds and properties, and although my investment choices are for actively managed funds my approach is rather passive with few actions being taken.
I think you can get a higher income yield than the 3.50% to 4.01% mentioned above from a number of alternatives. The UK equity income investment trust sector (average yield 4.00%) has 15 trusts with a yield between 4.20% and 5.60%. The UK commercial property investment trust sector (average yield 5.10%) has 17 trusts with a yield between 4.10% and 8.50%. I invest in these sectors and in the Global equity income, Asia Pacific income and Debt – Loans and Bonds sectors. These would also offer diversification across many companies or properties, and would be more of a hands-off investment. More information is available on the AIC website.
Reading the fame and fortune columns in the weekend press almost always has the famous favoring property over pensions. I interpret that as mostly older people reflecting on their past gains on their properties over the last twenty or more years. I have taken the opposite view and have consistently favored equities over property and have resisted buy-to-let. Looking back with hindsight there are times in the past when that may have been the wrong decision. I will explore that in a future post. Looking forward I think it is the right decision for me.