We would argue it is still an attractive asset allocation relative to other asset classes. Past performance is no indication of future performance, but it is good to know and over the past 25 years the average house price has risen from £68,823 to £202,689 — an increase of 295%.
Landlords have recently faced the double whammy of an increase in stamp duty as of April 2016 coupled with a cut in tax relief being phased in from 2017. So, if you’ve got £50,000 of savings to spare and want to get an income and some growth, which is better; the stock market or a property investment?
In both instances, we assume that you start with £50,000, which you’ve saved up in an Isa. That’s enough for a deposit for your property, or as the lump sum for your shares or funds.
Buy to let investment:
Your £50,000 is a 25 per cent deposit on a £200,000 property. For this loan size, you can get a five-year fixed-rate mortgage at say 3.59% interest-only. This means you make monthly interest payments on the debt and then repay the full amount at the end of the mortgage term — usually by selling the property. It keeps your payments each month lower. Interest payments would be £449 a month or £5,385 a year.
There are then associated “buying fees”; mortgage arrangement fees of say £2,625, the new increased stamp duty rate of £7,500 (3% on the first £125,000 then 5% between £125,001 and £250,000), legal fees of around £1,200, a home-buyer’s report £500 and a valuation £250. The total of all these fees is £12,075.
A bank will lend to you only if the rent is 25 per cent more than your mortgage payment, and the bank assume interest rates will be higher than they are now. So, for the above example, 5.24% (not 3.59%). For our £200,000 property we would need bring in rent of £820 a month.
Then there are of course, the usual running fees associated with property investment; buildings and contents insurance of say £200 per year, wear and tear, fixtures and fittings. Of course, you are allowed to deduct some of these running costs from your profits, though as of 2020 not the mortgage interest. From April 2016 until 2020, the amount of mortgage interest you can offset against the higher rate of tax will be reduced to just the basic rate of 20 per cent.
With the above mortgage on a £200,000 home, we estimate income as £10,200 per year. Under the new rules, to calculate your initial tax bill if you’re a basic-rate taxpayer, you will have to work out 20 per cent of your total income — that’s £2,040. If you’re a higher-rate taxpayer, you’ll work out 40 per cent of the total income — so £4,080. For both, you will get basic-rate tax relief of 20 per cent on the mortgage interest of £5,385, so £1,077. You will then deduct this from the first amount (that’s either £2,040 or £4,080), leaving you with a total tax bill of £963 if you’re a basic-rate taxpayer, or £3,003 if you’re higher-rate.
You finally need to deduct this and the mortgage interest you have paid in the year from your income — leaving you with a total income after tax of £3,852 if you’re a basic-rate taxpayer, or £1,812 a year if you’re a higher-rate taxpayer. Which might well be a long way off what you were expecting.
However, we are still to include the capital appreciation; lets assume a conservative annual growth rate of 5%. After 25 years your property would be worth £677,000. At this point, you sell the investment. You pay estate agent fees of say £7,000, you repay the mortgage and that leaves you with a profit of £470,000. Then there is capital gains tax. This is charged at 18 per cent for a basic-rate taxpayer and 28 per cent for higher-rate payers. A basic-rate taxpayer would pay 18% tax on £459,271 — so, £82,669. A higher-rate taxpayer would pay 28%, so £128,595.
In total, then, you could have taken income of £96,300 as a basic-rate taxpayer or £45,300 if you’re a higher-rate taxpayer over the 25 years. Your profit at the end would be £583,902 as a basic-rate taxpayer and £386,976 as a higher-rate taxpayer – as long as house prices rose at 5 per cent per year.
Investing in shares is much simpler.
Putting money in the stock market means you can get regular income in the form of dividends, as well as growing your capital as company share prices go up. The most complicated part of investing is picking your own stocks and shares. Lets assume you use the £50,000 Isa again and you don’t pay income tax or capital-gains tax on the money you take out of it. With investing, there are no upfront costs as long as you do it through a fund supermarket, you do however pay fees, but these are taken annually from your investment, lets say this is 0.4% per year. As well as this, you will pay an annual charge to invest in a fund, for example lets say the annual charge for a fund is 0.82%. We’ve assumed the same conservative annual growth rate of 5 per cent a year for the next 25 years for this, as with house prices. We’ve also assumed the fund pays an annual income of 3.5 per cent. On £50,000 after 25 years, you would have paid around £26,640 in fund supermarket fees, but you would have taken a total income of £65,141 and at 5% per year, your investment will now be worth £127,098 — a profit of £77,098.
Shares: total return of £115,000 and Buy to let profit of £386,000 or £583,000 depending on high or basic rate tax payer.
The main reason for the superior performance of buy to let is due to the loan or gearing. As you have borrowed money (your mortgage) the amount invested is proportionately larger. Similarly, any losses are also amplified on the downside.
There are other factors; interest rates in 25 years may be very different, there are letting agency fees, there are void periods……there is no denying that there a lot of “hassles” in residential property investment.
However, the superior returns (and the understanding of the asset) make residential investment compelling. Many people may not know a fund, or what it holds or what it charges, or indeed where the stock market is going. Residential property is a tangible asset, people understand it, and if the worst comes to the worst can live in it. Whichever you opt for it is imperative you seek professional advice. As you would likely seek a stockbroker or wealth manager to advise you on share purchases, so you should use a professional agency to advise you on investment property purchases.
This is what we at Osprey Lettings do.
The above is an example only, and we advise all purchasers to seek their own professional financial advice.