"Wealth is not his that has it, but his that enjoys it"
"Wealth consists not in having great possessions, but in having few wants"
"Time is the most valuable thing a man can spend"
- Laertius Diogenes
"The glow of one warm thought is to be worth than money."
"I don't care too much for money for money can't buy me love"
- The Beatles
"Simple, genuine goodness is the best capital to found the business of this life upon. It lasts when fame and money fail, and it is the only riches we can take out this world with us."
-Louisa May Alcott, Little Men
"And though I have the gift of prophecy, and understand all mysteries, and all knowledge, and though I have all faith, so that I could remove mountains, and have not charity, I am nothing."
"Not he who has much is rich but he who gives much"
"Life is what happens to you while you are busy making other plans"
"I pity that man who wants a coat so cheap that the man or woman who produces the cloth shall starve in the process"
A Guide to Investment Portfolios vs Buy-to-Let Property
- Is Buy-to-Let a Solid Investment?
- Buy-to-Let v’s Balanced Investment Portfolio
- Diversification & Flexibility
- Costs, Income & Tax
- Historic Comparisons
- Taking Advice
Introduction If you have money to invest, you may well be in the position of considering whether to allocate this towards purchasing a property and renting it out.
The buy-to-let market has boomed in the UK since the early 1990s with an estimated 2.5 million people becoming private landlords.
The attractions of this are:
- The British Public are familiar with property ownership, feeling it is a solid (possibly even safe?) investment, and an asset area which is reliable.
- There is the potential for a decent capital gain, from rising property prices.
- There is a regular income to be derived from the rental payments made by tenants.
However, the position is not as straightforward as this list may suggest, for two reasons.
1. Each of the statements above can be scrutinised further with pros and cons applied.
2. The decision to invest into a buy-to-let property can be compared to other ways the capital tied up in the property could be used.
This guide will focus on both points and will aim to provide a direct comparison between a buy- to-let property investment and a traditional-type investment portfolio.
Is buy-to-let property a solid investment?
Over the past two decades property investing has been ‘solid’ in the sense that property prices have tended to rise and there have only been short-term and very limited reversals in this trend. Figures from the Office for National Statistics, tracking prices starting from January 2005 to March 2020 highlight this.
During this period economic conditions have been favourable for property prices – the lack of housing stock, low interest rates and near full employment are all examples of this. There is a real danger, however, that such conditions may not persist.
Investors considering any asset area must be aware of common behavioural aspects, such as falling into recency bias.
This is a behavioural trait which describes giving too much credence to information and performance from recent times and ignoring longer-term records.
There have been many periods in the past when property has not performed well, for example most of the 1950s, the mid 1970s, the early 1990s and the period after the financial crash of 2008.
The depth, duration and extent of these various downturns varied, but all these periods evidence that the value of property can fall, and the property market is cyclical.
Investors should not assume property is safe, steady, or reliable.
Furthermore, today (early 2021), the relationship between property prices and average wages, sees the highest level of multiple. The average property is currently 8.5 times the average wage in the UK.
The long-term trend shows this figure around 4.5.
According to a Bank of England paper released towards the end of 2019, the increase in this figure can – at least to a large extent - be explained by interest rates, which are at historic lows and have been for some years.
Otherwise, the figure is unlikely to be sustainable, which suggests that if there were any upward movement in interest rates, property prices may well fall and, perhaps, significantly.
There is the potential for a decent capital gain, from rising property prices.
Based on the points above, for property prices to continue rising, either the 8.5 multiple must increase even further (which it has never done before) or wages need to go up.
This does suggest that the current state of play, early in the 2020s, indicates that property is probably ‘expensive’ at worst or ‘not cheap’ at best, relative to some key markers and long-term trends.
Investors benefit most when they allocate their capital to asset areas which are good value. Property prices may well continue to rise, but there is no guarantee nor is it risk free.
Capital losses from investing into buy-to-let property must be considered a real risk.
There is a regular income to be derived from the rental payments made by tenants.
One of the key attractions for investors is the regular income that can be derived from renting out a property.
As of December 2020, rental yields on buy-to-let property varied considerably across the UK, ranging from an average 2.9% in London to 6.6% in Northampton, according to Aldermore’s 2020 buy-to-let city tracker.
With interest rates at such low levels, meaning the returns from savings accounts are negligible, these yields look attractive.
If you can invest in property and get, say, 4%-6% per year, compared to, say, 1%-2% per year from a savings account this could work well. However, it is not a direct comparison, for two reasons:
1. A Savings Account has no capital risk – there is no prospect of losing money whereas, as discussed above, property values could fall. There is a capital risk with buy-to-let property.
2. A rental yield is quoted ‘gross’. For example, if you buy a property for £250,000 and rent it out for £1,250 per month, that represents a 6% per year yield. This does not take into account, legal, maintenance, agents, insurance any other costs. All of which could reduce that yield considerably.
There is also another aspect – the risk of having a problem tenant and potential void periods.
Non-payment of rent can be a real problem for landlords, who may not only face an absence of payment, but must deal with legal costs in recovering outstanding sums, or worse, enforcement or eviction.
Investing into buy-to-let property is clearly a viable option when you are deciding how to allocate your capital, but each of the main reasons why this is attractive, have counterbalancing, potential, disadvantages.
CONFIRMATION AND AVAILABILITY BIASES
Other common biases which can exert influence over investors are confirmation and availability biases. News stories about ‘ordinary people’ becoming property millionaires may play towards these biases.
If you consider property a good investment and you read about this type of success story it reinforces your view (confirmation bias).
You may also be reading about the outliers, the ones who make the news, and not all the other stories where the success is not as marked or is entirely absent (which is an availability bias because you are only seeing a small part of the complete picture).
Comparing Buy-to-Let Property as a long-term investment versus a Balanced Investment Portfolio
A Balanced Investment Portfolio is one which includes a mix of assets, such as shares, fixed interest investments, cash and possibly property funds (as opposed to a but-to-let property). It could also include other assets, depending on the risk position of the investor, a good example would be holding some allocation in commodities. If you are looking at options around how to invest your capital, it could be that you face a choice between buying a property to rent out or putting the money into a balanced portfolio.
To explore this further we will look at two aspects:
1. Generally, how the options vary, the pros and cons of each – as measured against each other.
2. Some historic comparisons of returns.
How the options vary, the pros and cons of each – as measured against each other.
We will assume an investor has £100,000 available to invest and is weighing up buy-to-let or investing into a balanced portfolio. Some of these considerations may vary depending on the amount available.
- The first thing to note is that £100,000 in most areas of the UK would not be sufficient to buy a property outright. Therefore, most of such property investments are facilitated with the help of a mortgage. The mortgage, if available, allows for a much higher investment to be made. For example, the £100,000 acts a deposit on a £300,000 purchase, with a £200,000 mortgage arranged.
- This has the effect of ‘leveraging’ the investment – which can inflate the returns made if the property rises in value.
- If the property value doubles over ten years, then the sale value becomes £600,000, the mortgage would still be £200,000 repayable, leaving a net position of £400,000 if the property were sold.
- The £100,000 has turned into £400,000 from the doubling in value of the property. The ‘leverage’ has had the effect of increasing the investment fourfold.
- £100,000 placed into an investment portfolio which also doubles in value over ten years becomes £200,000.
- The leveraging gives the buy-to-let option a distinct advantage.
- However, this only works if property prices increase, if property prices halved, then the exact opposite position applies – the property investor would have turned £100,000 into negative £50,000 (they would owe more than the value of the property), whereas if the investment portfolio halved, they would still have positive £50,000.
Leveraging acts as a form of a bet, it is good for the buy-to-let position providing property prices go up. If they do not go up very much it makes little difference.
If they go down, it is bad.
- A key difference between a buy-to-let property investment and balanced portfolio is that the portfolio can provide a much greater level of diversification.
- The capital can be split amongst different assets types, for example £20,000 into UK Equities, £20,000 into Overseas Equities, £20,000 into UK Fixed Interest areas, £10,000 into Overseas Fixed Interest areas, £10,000 into Property Funds, £10,000 into Commodities, £10,000 into Cash.
- The buy-to-let is 100% into the one type of asset.
- Evidence from multiple research sources and papers, over many decades, shows that diversification provides one of the best ways of achieving good long-term returns and helps to manage risk.
The diversification achieved by using different asset areas within an investment portfolio is a major advantage.
- A buy-to-let property investment is inherently inflexible; making changes to this can be difficult and/or expensive.
- For example, if you want to sell, this can be time consuming and slow and if you have tenants in the property even slower.
- If you wish to change tact quickly (because you may no longer want to invest in property because of a difficult market) your ability to make a quick change is extremely limited and there is no guarantee of a buyer on hand.
- Contrast this with an investment portfolio, where changes can probably be made in a matter of hours. • And with the investment portfolio you can make regular changes – every year, as conditions dictate.
- It is tricky, if not impossible, to part sell a buy- to-let property whereas an investment portfolio can be changed in part. For example, if you require £20,000 of your £100,000 released for some purpose, that is easy to arrange with an investment portfolio.
An investment portfolio is more flexible, in the sense that it is easier to change tact, make suitable alterations due to new circumstances and to organise a sale of the holdings.
Costs and Charges
- Costs on a buy-to-let property can be extensive.
- They can also be ‘unknown’ in advance.
- The costs include stamp duty, legal fees, agent fees, arrangement fees (on a mortgage, for example), and property maintenance costs.
- Void rental periods are a potential hidden cost.
- Costs on an investment portfolio are likely to be lower overall, certainly on a sum of £100,000. With typical costs including an annual investment fee of between 1% and 2% of the invested sum.
Comparing costs and charges between the two options is difficult, there is no easy like-for-like basis. The nature of the costs involved in each are different, although in most cases it is considered the costs will likely be higher with a buy-to-let.
- A buy-to-let property investment generates rent which is used to provide the income return on the invested sum. This income level will probably be higher than a suitable income from an investment portfolio.
- The income from an investment portfolio is going to be dependent on the type of assets held within the portfolio. The two biggest assets areas and the income they will typically pay in the current climate, dividends from shares and interest payable on bonds (such as government gilts) are likely to be 2% or so lower per year than the rental yield from a buy-to-let property.
- In both cases there is the potential for the income level to grow over time. Rental payments from a buy-to-let may increase as rents are put up every year, the income from an investment portfolio could also rise if the assets perform well.
Perhaps the standout feature of the buy-to-let option is the regular and growing income it can provide. This is likely to be higher than with an investment portfolio, although also slightly riskier. This is due to the risk of a tenant missing payments, or the property having void periods for any length of time.
- The tax position on both buy-to-let and an investment portfolio will be circumstantial, dependent to some degree on the investor’s tax position.
- Property rental income is subject to income tax. This can be offset by some ongoing costs, which reduce the level of tax payable.
- Previous generous tax breaks on income from a property in relation to mortgage interest no longer applies.
- The sale of a buy-to-let property is subject to capital gains tax.
- There is very little potential to shelter such an investment from these taxes, and others including Inheritance Tax. • On an investment portfolio, the tax position is dependent not only on the investor’s position but also the type of ‘wrapper’ used to hold the invested sums.
- An ISA, for example, can be used to shelter the capital and income from taxation.
It is much easier to be tax efficient with an investment portfolio than it is with a buy-to-let investment. The tax position comparison, like the cost position, is difficult to summarise because the two options have very different aspects and are closely linked to an investor’s own affairs. However, generally it is fair to say there is more scope with an investment portfolio to shelter from taxes payable.
Some historic comparisons of returns
There is very limited or reliable research around historic returns for buy-to-let property.
House price figures are available going back many decades, which helps but it is the specific buy-to-let data that is difficult to find. This may be because the nature of such investments is that they are individual, scattered across millions of private landlords and there is no buy-to-let index.
Whereas asset areas such as shares, and gilts have established market mechanisms and indexes which provide accurate historic returns data.
This makes comparing the two options difficult.
Research at the end of 2019 by Brewin Dolphin (1), comparing stocks and shares with buy-to-let property showed a position on a notional investment of £100 in 1986. £100 invested in the stock market in 1986 would have accumulated a total of £1,755 by December 2019.
The same sum invested in a buy-to-let property would have produced a return of £739. This analysis used certain assumptions about rental yields which leads to these conclusions (they assumed a notional 5% rental yield against ongoing house price values) – any variance of this at an individual level could have produced a different comparison.
One aspect of this research is that there was no allowance for the fact that many private landlords use a mortgage to leverage their investment, which would have a profound effect on the buy-to-let figures.
This is highlighted by another study produced in 2015 (2) which showed where a 75% mortgage was used, buy-to-let overall returns from 1996 to 2015 was 16.2% per year, way ahead of the average return from shares.
These and other similar efforts at comparing the options are probably fruitless for the various reasons already alluded to. So much is dependent on an individual investor’s own circumstances, their risk position, their tax position, their other assets and finances, their age, and their location.
The goalposts move over time, so take a snapshot today and your conclusion could be quite different from one taken ten years ago or one in ten years’ time. Tax rates change, market conditions change. One option is not better than the other, they are exactly what they are described as – options. With very different dynamics attached to them.
The decision where to invest your savings is always going to be dependent on a wide range of factors.
There is no easy way of knowing which asset or type of investment is going to produce the best return. In any event, determining what definition to apply to ‘best’ is difficult, if not impossible.
Therefore, decisions must be made taking a balanced view of one’s circumstances and objectives. The buy-to-let investing option has the advantage that returns can be leveraged (using a buy-to-let mortgage) and this, it seems, gives it a potential edge over other options provided the property price increases. But that is a big proviso, and it could be that the risk has increased in recent times, due to the historic high point between wages and property prices and the removal of certain favourable tax breaks for that type of property purchase.
The investment portfolio option is more flexible and has more scope to work within a changing world – and it is easier and, probably, less costly to manage.
As the options are so inherently circumstantial – your decision on where best to invest is ultimately going to have to be assessed on your personal requirements and financial position. Taking advice allows you to work with a professional to weigh up all the relevant factors, look at the pros and cons in relation to your own circumstances and then reach a suitable decision.
Receive the Full Guide and Subscribe to our Newsletter
You can unsubscribe at any time
Getting Help And Support
Readers should not rely on, or take any action or steps, based on anything written in this guide without first taking appropriate advice. Interface Financial Planning Ltd cannot be held responsible for any decisions based on the wording in this guide where such advice has not been sought or taken. The information contained in this guide is based on legislation as of the date of preparation and this may be subject to change.