Is Buy-to-Let the New Pension?

Buy-to-let has gained a lot of popularity in recent years as a source of retirement income.

It has long been popular as a way to supplement a pension, but increased levels of freedom in the way pension pots are spent have led people to incorporate this more prominently into a retirement plan or even use it as an outright substitute for purchasing an annuity.

But is it an adequate substitute for more traditional options?

At present, there is at least a perception that buy-to-let gives a better income for retirement than the standard option of buying an annuity. However, potentially even more important than examining whether that is true at present is analysing whether it will remain true as certain government reforms roll out.

The government has announced quite a number of reforms which are actively designed to reduce the profitability of buy-to-let. Some of these have already been implemented, while others will continue to roll out for full implementation by 2020.

One of the key areas of reform to already take effect is stamp duty. Since April, those who purchase a residential property beside their primary residence face an extra stamp duty surcharge of three percentage points. How much this means in real cash, of course, depends on the value of properties in the area in which you are buying. This varies massively across the country – in some areas of London, the average stamp duty bill is over £135,000 while in Neath Port Talbot, the cheapest place in the UK, it’s just £455.

In the run-up to 2020, tax changes rolling out in stages will harm the profitability of buy-to-let investments with a mortgage, which represents the majority of such investments. In particular, higher rate taxpayers will find their investments taking a hit as they lose the ability to offset mortgage repayments against income. Some may even see properties become loss-makers as their tax bill outweighs their profit.

Next January will also see changes to lending rules, making buy-to-let mortgages more difficult to obtain. This is likely to hit smaller-scale landlords especially hard, and this is the group that most landlords seeking a pension alternative fall into.

Even so, many potential landlords who can put up a decent amount of the property’s value as a deposit may still find property a viable and even attractive option in the coming years. This is especially true of basic rate taxpayers who will escape the harshest of the tax reforms.

As for how this compares with an actual pension, the most up-to-date picture comes from a recent analysis by AJ Bell. In this analysis, the performance of £100,000 over ten years was forecast in each of three scenarios; a traditional pension, a single investment property with no mortgage, and three investment properties with mortgages worth a total of £300,000. Additional costs such as stamp duty are included in the analysis.

When both capital growth and rental income are considered, buying multiple properties is expected to be the best bet even with borrowing involved. This would see the total value of the £100,000 investment grow to a total of £244,020 made up of £171,600 in the properties’ value and £72,420 rental income.

In a pension pot, the value of the £100,000 investment would grow to £203,612 but deliver no income. Investing in a single property with no borrowing is predicted achieve the lowest returns, reaching a value of £164,275, but provide an expected income of £41,180 while equity in the property also grows to £123,095.

Read also beginners guide to rent your first property for better understanding.

This article was provided by Hopwood House, property investment specialists who provide international investment opportunities to investors both at home and overseas.

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