Getting into the buy-to-let market might seem like an appealing choice. Indeed, according to investment specialist BondMason, over the past three years, buy-to-let landlords have achieved a combined 17% post-tax return assuming a 65% loan-to-value mortgage, 3% p.a. interest and a 4.5% rental yield.
However, when we look at the profits equity investors have achieved over the same time frame, these gains don’t seem so appealing.
For example, during the past three years, the FTSE 100 total return index has produced an average annual gain of 10.3% for investors implying that every £100,000 invested in the UK’s leading blue-chip stock index is worth £134,200 today, compared to £117,000 for buy-to-let.
The better buy
They say a picture paints a thousand words, and in this case, these figures tell the whole story.
Over the past three years, equities have achieved a vastly superior performance to buy-to-let property. And as new tax changes come in, I think this trend is only going to become more pronounced in the next three years.
Tax changes
Starting from next year, landlords will be restricted to claiming a basic rate of income tax on their mortgage interest costs, while having to pay their full tax rate on the rental income, which could tip some investors into a loss-making position.
At the same time, the government has recently introduced a range of new measures to prevent landlords taking advantage of tenants, including the right for tenants to sue landlords if their properties fall into a state of disrepair.
Some estimates suggest that landlords could see their tax bills double or triple over the next three years thanks to these changes, which, when combined with higher maintenance costs and other administrative costs of managing a buy-to-let property, could tip these property owners over the edge.
At the same time, home price growth is slowing down. In the past three years, house prices have grown by a total of 6% according to the Nationwide house price index. However, it now looks as if growth has come to a halt, meaning buy-to-let investors can no longer rely on capital gains boost their long term returns.
Bleak outlook
All of the above means it is difficult to recommend buy-to-let as an investment proposition. Instead, equities seem to me to be the much better choice.
Not only have equities produced better returns over the past three years, but you can also build an equity portfolio with relatively little effort, and you do not need to find someone to manage the portfolio or keep it up to a certain standard like you do with rental property.
Further, you can invest in equities via an ISA wrapper, which means that any dividends you receive or capital gains booked are not subject to tax — you don’t even need to declare the assets on your tax return.
The bottom line
So, if you are thinking about getting into the buy-to-let industry, then I highly recommend considering all of the above before you do.
Not only are the returns from buy-to-let set to fall, but it is also going to become harder to generate a profit as the government increases the tax obligation for landlords. Stocks just might be the better bet.