Who needs a pension plan when you can build a property portfolio!
It’s not surprising that many people have decided to invest in bricks and mortar. Especially when headlines shout about pensions not working due to miss-selling scandals and perceptions that the UK equity market has been disappointing over the last decade. Add to this the stories of buy-to-let investors gaining from increasingly high rental incomes and a high demand for properties to rent due to the growing population and first time buyers struggling to get on the property ladder. Landlords are making hay; or are they?
Property is seen as an alternative for some
Savers who previously relied on income gained from their cash deposits have been feeling the pinch with rates below 1% (before inflation and tax). They’ve had to seek an alternative means of income. This has included more risky low quality ‘high yield’ bonds and higher yielding equities or property.
Investing in buy-to-let property for some didn’t feel too far out of their comfort zone, especially if they already owned a property and had a mortgage. But in reality they were starting a very highly geared business, one that brings with it operating costs, tax and reporting and financial risk.
Borrowing to invest has its risks and rewards
Some landlords may buy their properties for cash but very often a 75% loan to value mortgage is arranged. This means that on a property worth £150,000 a cash deposit of £50,000 is made and a buy-to-let mortgage of £100,000 is arranged. In other words a gearing of three times the cash invested.
Can you imagine asking a bank manager to lend you three times the value of your investment portfolio to ‘gear up’ your investments? He’d think you were mad and politely show you the door!
Property prices do not keep increasing, there are inevitable dips. We saw big decreases in the mid-1980s, 1989 and 2007. So in the example above if the property increased by 20% over a period of time the investor would have seen a return of 60%. However, if the market were to decline by 20% they would have lost £30,000 on their capital investment of £50,000. Negative equity has been the curse of many a landlord.
Getting the numbers right
We wonder how many landlords actually had a good grasp of the numbers involved when they started. There are many costs involved; some obvious and taken into consideration others come as a nasty shock:
- Initial costs – purchase investment, stamp duty and legal fees. Perhaps some repairs and redecoration. Definitely gas and electrical checks and certificates
- Ongoing costs – buildings and landlord insurance, white goods and general maintenance. Leaseholds will require service charges and/or grounds maintenance. Agent’s fees if it’s not being looked after by the landlord. Void periods, mortgage payments.
- Sale costs – agents fees and capital gains tax
When these numbers are crunched the true net yield is not quite so appealing than at first it might seem. In reality, after tax, it might be a little over 2% on their capital. Buy-to-let is a long term strategy reliant on price appreciation and timing plays a bigger factor.
Property and pension plans
When it comes to property a smart investor knows the numbers and would look dispassionately at the total return on property investment based on both yield and capital gain.
With pension plans, they would look at the valuable tax breaks as an important part of the capital accumulation process available to those who make pension contributions. A £50,000 pension contribution is worth £83,000 on a gross basis based on a 40% rate of tax.
Property does have a place within a pension plan. But we see this through global commercial property, a collective investment scheme or even as part of a self-invested plan. Residential property cannot currently be held within a pension plan. Such a pension plan is well balanced and diversified unlike a concentrated high-risk buy-to-let portfolio.
Pension funds over property every time
Unlike the headlines lead us to believe, buy-to-let is not a get rich quick strategy. To have a chance of being successful it has to be approached in a business-like manner, which perhaps was not the intention of many when the original investment decision was made; certainly not the management headache that usually accompanies the title of landlord.
At Swindells Financial Planning we believe that making the most of the tax breaks and investing in suitably structured, globally diversified investment portfolios makes sound sense and should remain at the core of a retirement plan.
If you wish to discuss how you can benefit from investing in a well-balanced pension plan, contact us on 01825 76 33 66 or use the form on the contact page to book a consultation.