If you add up everything that everyone owns you’ll find that residential property accounts for about 45% of it. The global housing stock is worth over $165tn, by far the largest asset class, easily beating out securitised debt (approx. $100tn) and equities (approx. 70$tn). It appears that home is where the wealth is.
Rental properties account for a good chunk of that wealth. The total return on a property investment comes from two sources: capital appreciation (house prices going up or down) and income (rents).
The annual total return for UK real estate was 7.63% on average for the period from 1963 to 2015, according to a 2019 Federal Reserve Bank of San Francisco report called The Total Risk Premium Puzzle.
Say the words “buy to let” to someone on a UK high street, and they will probably understand. They may even have done it themselves, possibly as an alternative to a pension. They could point to that 7.63% average annual return as justification for their investment. But should they?
Renting returns
In 2018, the median UK house price was £228,000. To buy a median house, you would have to put down a deposit. A 10% deposit is £22,800, and a 20% deposit is £45,600. The rest will need to be borrowed from a bank and secured against the property (a mortgage).
According to the Office for National Statistics, from 2016 to 2018, the average mortgage payment was £8,055 per year and the median rental income was £8,100 a year. This means that it takes 25 years or so of just about covering the mortgage payments to have truly bought a property to let. That’s when you can start to enjoy the 7.63% average annual return.
Not necessarily. Just as I used average house prices, rents, and mortgage payments, 7.63% is an average. It tells you what you can expect to get each year on average if you had held substantially all of the property in the UK over the last 60 or so years.
An investor owning a single property cannot expect this return. It might be higher, and it might be lower. House prices do not always go up, and tenants do not always pay their rents. Multiple properties in different locations are needed to get the average return, which is beyond most buy-to-let investors.
Taking stock
The total return for UK stocks and shares was 8.74% in the same 1963–2015 period, according to The Total Risk Premium Puzzle. If I were choosing between investing £22,800 in UK stocks or using it as a 10% deposit on a buy-to-let property, I would go for the shares.
There are no mortgages to pay with shares, no tenants to chase for rents, and they don’t require upkeep. I would use 80% of the £22,800 to buy a FTSE 100 index tracker, and the rest to buy a FTSE 250 tracker. My risk would be spread across 350 companies, rather than in one property.
Assuming an 8.74% average annual total return and investing the £8,055 average yearly mortgage payment, the portfolio could be worth £841,714 after 25 years. What’s more, I would have no trouble cashing out. Would the buy-to-let property be worth as much?
With buy-to-let investing, the net yearly cash flow may be negative, but you are liable for the annual mortgage payments whether you collect rents or not. If you can afford the mortgage payments, then you can afford to invest them, so the strategies are comparable.
For some people, buy-to-let investing meets a specific, well-defined objective, or it’s their business model. I am not trying to discourage them. But for a straightforward toss-up between investing in stocks or property, I would plump for the stocks.