To buy-to-let or not to buy-to-let, that is the question
In the first of our series looking into property as an investment, Goodmans’ Financial Planner, Tom Clark, explores the risks of investing in buy-to-let property versus the stock market.
Let's face it, telling people that you invest in real estate sounds a lot more exciting than saying "I invest in a diversified, low-cost, global stock market portfolio." Pretty boring, right? Well, sorry to be a bore, but for a lot of people, that dull sounding portfolio is the most suitable approach!
Credit where credit’s due, investing in property can work, but it comes with plenty of uncertainty and risk.
A look at some risks
Given the high price tags involved with property, most people need to take on a mortgage and the leverage risk that comes with that debt. Currently, as many are painfully aware, there’s some interest rate risk too. And you need to be willing to place most of your eggs into one (bricks and mortar) basket.
At the end of the day, you’re relying on your own due diligence in buying the right property, at the right price, in the right location, while betting that you can sell at the right time too. That’s a lot of things to get right. I’ve learnt how hard this is, both personally and from my parents’ experiences.
The short and the long term
It's important to remember that there’s a lot of ‘noise’ when it comes to investing your money. One such noise is the notion that property always goes up in value. which has largely gained traction due to the many TV shows glamourising buy-to-lets. When people buy and hold investment properties for many years, even decades, the not-so-shocking result is that their house price keeps going up!
But I bet if you picked a random person off the street every day and asked them how much they’d pay for your house, the price the open market would be willing to pay would be very volatile indeed. You could (rightly) say that the same can be said of the stock market over a very short time horizon. But, similarly, in both cases, patience pays off. Over the long term, both property and stock markets will offer a remarkably consistent upwards trend of capital appreciation.
Tuning out the noise
With all that noise confusing things, it’s critical to focus on a simple investment philosophy, backed by research and evidence, that lets you tune out what’s not relevant. This is one of the areas where a Financial Planner adds real value. As long-term investors at Goodmans, we’re disciplined enough to not react to short-term factors that move asset prices, instead taking a birds-eye view over time.
The way I view buy-to-lets is to treat them like any other business. As a landlord, you’re essentially a business owner, with the tenant being your client. Once you’ve chosen to retire from work, would you want the hassle of running a business and relying on that capital for the remainder of your life? That doesn’t sound like ‘retirement’ at all!
Other things to consider
That’s just a few of the long-term, bigger picture reasons why I believe a sensible, low cost, diversified global stock portfolio is the most suitable approach for many people. Here are some other, more immediate negatives that affect buy-to-let investors much more than the patient portfolio investor.
This is a big one. Investing in a physical property means your capital is locked away, making it a difficult, long and expensive process to gain access. Meanwhile, with a portfolio you can generally make ad-hoc withdrawals whenever you like and receive your money within a couple of weeks. I’ll admit that having your capital locked away could be seen as a benefit as this can avoid impulsive purchases at your long-term expense. But assuming we’re all disciplined and patient investors, this is certainly a very big con if you need your money in an unforeseen emergency.
Landlords are very much out of favour with politicians and carry little sympathy from the general public. This has resulted in the increasing erosion of the tax benefits buy-to-let investors once enjoyed. Now, investing in property is subject to higher Capital Gains Tax than stocks, and rental income is taxable under Income Tax. Even mortgage interest is no longer fully tax deductible.
On the other hand, in an investment portfolio we have many tax-efficient tools at our disposal. ISAs, for example, are sheltered from personal tax, while pensions enjoy tax relief (free money!) and, unlike property, aren’t captured by Inheritance Tax. And both benefit from tax-free growth, so no Capital Gains Tax to worry about. There are other investment accounts we can use with various reliefs to further boost tax efficiency. Conversely, buy-to-lets remain very restrictive when it comes to tax planning.
This one is pretty simple really, and I’m sure very few people will disagree here – buying, owning and selling properties can be very expensive compared to a low-cost investment portfolio. It’s easy to think your rental income is a second income, but come self-assessment day, it becomes clear that maintaining an investment property to the ever-increasing higher standards is costly. If you have to kiss goodbye to the lion’s share of your profits for that tax year, you might ask yourself if all that work was worth the reward. I know I did.
The power of hindsight
It’s not every landlord’s experience, but for my parents, the negatives of buy-to-let ownership were compounded by having to take their tenants to court to pay for damages. For them, the added stresses, costs and extra hours worked all went uncompensated over 15 years for a sub-par result. I asked them the question: “With all that you know now, do you think you’d have been better off investing in a sensible portfolio than the buy-to-let?” I got a resounding and somewhat glum answer: “Yes”.
If you go into it with your eyes open and enjoy the notion of running a buy-to-let ‘business’ and everything that entails, then fill your boots. But I’d question anyone who argues that investing in a well-diversified portfolio brings more risk and lower rewards than buy-to-let property. We know from reams of academic research that, if sensibly invested in global markets over the long term, risk and reward are positively correlated. Meanwhile, investing in real estate can expose you to greater unknown risk, which tends to go uncompensated.
So I have an answer to the title question: To buy-to-let or not to buy-or-let? For me, I think not.
If you want to have a chat about the most suitable way to structure your investments, contact us.
This article should not be considered investment advice or an offer of any product for sale. It does not represent a recommendation of any security, strategy or investment product. All information has been obtained from sources believed to be reliable but is not guaranteed. Past performance is not indicative of future results and no representation is made that the stated results will be replicated.