Is buying rental property better than a pension?
The buy-to-let market is on the up again, but should you stake your retirement on bricks and mortar?
‘My property is my pension’ is an oft-used phrase when discussing retirement, but how sensible is it to ditch the pension plan and plough money into bricks and mortar to support your old age?
Despite government initiatives to boost homeownership, the number of long-term tenants is increasing as people struggle to get a foot on the property ladder. According to research by Legal & General around 31% more households are in private rented accommodation than they were in 2007, and the number of homeowners has fallen 2% over the same period.
Homeownership over the medium- to long-term is expected to dwindle even further, from 68% in 2007 to 57% in 2020; meaning 1.6 million fewer households will own a home compared with the 2007 peak.
There are plenty of people taking advantage of this rental boon. Council of Mortgage Lender (CML) figures show there are now 1.42 million buy-to-let mortgages in operation, compared with 89,000 a decade ago.
Many landlords are taking a gamble on buy-to-let as a way to pay for their old age, pumping money into the property market instead of a pension.
Should you join them?
The pros of property
One reason to get on the landlord bandwagon is that the yield on rental property is going up. Property website Rightmove puts the average rental yield at 5.73% a year. Estate agent Countrywide is even more optimistic, placing average rental yields at 6.2%, and stating that one in 10 properties is delivering a gross rental yield of 10% or more.
For investors struggling to find decent returns without a high-risk investment strategy, investing in property in a local area is often a more palatable option. For some people, owning a tangible asset such as bricks and mortar is preferable to more intangible assets such as shares, funds and bonds.
Property also provides the opportunity for both capital growth and income, so on retirement you could sell the property, hopefully having made a profit, and you would have a bulk sum to put into a pension or live off. Equally you could continue to rent out the property and live off the income, although to do this you the mortgage needs to be paid off.
David Hollingworth of mortgage brokers London & County said people are increasingly seeing their property as part of their pension plan but would not swap one for the other completely.
‘It is not necessarily one or the other,’ he said. ‘Investing in property allows you to diversify but putting all your eggs in one basket is risky.
‘The poor returns on cash have renewed people’s interest in buy-to-let. Rental demand is still strong and property is giving people a good income. It is not just income now but it could also be [giving income] they have retired.’
Good deals available
Figures from CML support Hollingworth’s view that the buy-to-let market is picking up. Although buy-to-let lending is way off its 2007 peak when 346,000 mortgages were advanced, the number of mortgages advanced has been increasing since the low of 88,400 in 2009.
Last year 136,900 buy-to-let mortgages were advanced, totalling £16.4 billion.
Mortgage rates for owner-occupied properties have been falling since last summer, but buy-to-letters have been enjoying low rates for a couple of years, said Hollingworth, and are also able to still take advantage of interest-only mortgages unlike owner-occupied borrowers.
‘Buy-to-letters can still take out interest-only mortgages, but lots of people will look to pay down the mortgage so in later life they are not left in debt and they can use the [rental] income to fund retirement, although they would need to put some money aside for running costs of the property,’ he said.
He said that buy-to-let mortgages were good value; The Mortgage Works is offering a two-year fixed deal for 2.74% if you have a 35% deposit, although the fee is 3.5%.
Hinckley and Rugby Building Society is offering a two-year fixed deal on 60% loan-to-value of 2.85% and a fee of £2,200.
And for those who want to fix for longer Clydesdale Bank is offering a five-year fixed deal of 3.99% on 60% LTV for a £1,999 fee.
‘Buy-to-let mortgages are good value, but you still have to put down at least 25% deposit most of the time, so buy-to-let isn’t without its difficulties,’ Hollingworth said.
‘That is one of the distinctions between a pension and a property, property works less on a drip-by-drip basis, you need to have a substantial amount of capital behind you.’
The long game
People who think they can ignore their pension and plough money into property to make a quick buck will be sadly mistaken. Like a pension, property investment is a long-term strategy, Hollingworth said.
‘People need to see property investment as part of their pension plan, going into buy-to-let for short-term gain is not worth it,’ he said, noting that the cost of buying and selling property is high thanks to stamp duty, estate agents and legal work.
‘There are lots of risks associated with buying property and you have to buy a property that you think will be consistently attractive to tenants and will be full at all time, you still have to pay the mortgage in void times,’ he said.
While an empty property may pose some short-term problems, property investment could pose a longer-term problem.
‘I would hope that over the longer-term property prices will rise… but what happens if you want to sell the property to fund your retirement and that market takes a dive, that could be a big problem,’ Hollingworth said.
Danny Cox, head of financial planning at Hargreaves Lansdown, said investing in property for retirement is not a bad idea but it should not be done at the expense of saving into a pension or other more tax-efficient wrapper.
‘Pensions are more accessible than property, you don’t need a huge chunk of money to save into a pension and you receive tax relief on your pension contributions,’ he said.
‘Property as an asset, excluding your own home, is one of the least tax efficient types of investment. You pay capital gains tax on any increase in value when you sell, you pay income tax on the rental income, you can offset some expenses but that’s money you’ve already spent.’
Cox said more buy-to-letters assume that the mortgage will be paid by the rental income and the capital value of the property will go up but there is the risk that the rent only cover the mortgage interest, capital value falls and there is no way to pay off the mortgage when you come to retirement.
‘Property as an investment can work well but it should not be used as the only way to save for retirement,’ Cox said. ‘You should diversify your retirement plan… Lots of people say they are not going to save into a pension now because they are going to invest in property in the future but they need to save into something now, whether that is a pension or somewhere else.’
Article courtesy of Citywire