Buy To Let or The Stock Market?

Nikka Sulton

Buy To Let or The Stock Market?

Buy-to-let property investment, once heralded as a dependable source of income and a pathway to financial stability, has faced challenges in recent times, leading to a shift in its perceived profitability.

Traditionally, individuals looking to secure their financial future turned to buy-to-let properties, viewing them as tangible assets with the potential for long-term returns. Landlords often relied on rental income from their property portfolios to supplement their earnings, with many seeing it as a crucial component of their retirement plans.

However, the landscape of property investment has undergone notable changes in recent years. Government interventions, such as increased taxation and stricter regulations, have altered the dynamics of the buy-to-let market. These measures, aimed at addressing concerns surrounding housing affordability and tenant rights, have had a significant impact on the profitability and viability of property investment for landlords.

As a result, the allure of buy-to-let investment has diminished, with some investors opting to explore alternative avenues for wealth accumulation. While property investment still holds potential, particularly in regions with robust rental markets, the evolving regulatory environment and associated costs have prompted investors to reassess the feasibility and sustainability of buy-to-let ventures.

Currently, there’s a growing sentiment among individuals and landlords that the viability of rental investing, particularly buy-to-let, is diminishing. Several factors contribute to this perception, including:

Significant disparity between property price increases and income growth.
Policy alterations that discourage landlords and prospective investors, such as higher stamp duty rates and the gradual elimination of income tax relief on mortgage payments.
Declines in confidence and demand following the Brexit referendum in June 2016.

Real estate vs. stocks: Which makes more money?

When comparing the potential returns of real estate and stocks, several factors come into play. The average annual return of the stock market, represented by the S&P 500 index, stands at around 10%. While these returns fluctuate annually, over time, investing in an S&P 500 index fund typically yields approximately 10% minus inflation.

In contrast, Real Estate Investment Trusts (REITs) have boasted an average total annual return of 11.9% since 1972. However, it’s essential to note that REITs may not consistently outperform the S&P 500. Each investment demands careful evaluation and integration into your overall portfolio strategy. Opting for both an S&P 500 index fund and a REIT can enhance diversification, offering a balanced approach to investment.

What Is The Return On A Buy-To-Let Property?

A competitive property rental yield in the UK typically ranges from 6% to 8%, according to NatWest. However, this figure often overlooks additional expenses such as stamp duty, legal fees, insurance, repairs, letting agent fees, and periods of vacancy, which can erode your expected yield.

While rental income may cover expenses, it often yields minimal profit. Additionally, capital growth potential is a factor to consider, with UK house prices experiencing significant increases over the years. Yet, selling a buy-to-let property incurs various costs, including capital gains tax, energy performance certificates, estate agent fees, conveyancing solicitor fees, mortgage exit fees, and removal costs.

For instance, selling a property at the average UK house price involves expenses totaling around £4,901, excluding mortgage charges and other fees. Considering a property’s appreciation from £171,000 to £286,000, the after-tax profit can be substantial, but landlords may find the rental market less lucrative due to increased tax liabilities and uncertain price growth prospects, particularly amid rising interest rates.

What About Stock Market Returns?

Comparing an investment in the stock market with putting around £170,000 into rental property in 2013 reveals intriguing insights.

Business Insider reports that investing in the S&P 500 would have yielded an average return of 10.7% since its inception, and 14.7% in the last decade up to 2022. Similarly, IG notes that the FTSE 100 has delivered an average annual return of 8.4% over the past ten years and 7.75% since its inception.

Monetarily, stocks appear to outperform rental property. For instance, £170,000 invested in the S&P 500 a decade ago would be valued at £419,900 today, while the same investment in the FTSE 100 would be worth £312,800.

However, outcomes vary. A property’s substantial appreciation or ill-timed equity sales can significantly impact returns. Moreover, capital gains tax applies to investments, unless sheltered in tax-efficient accounts like an Isa or Sipp.

Consider also the level of effort required. Stock picking demands extensive research, whereas investing in an FTSE 100 tracker is relatively hands-off. Conversely, managing rental property entails legal obligations, such as safety certifications and tenant vetting, with severe penalties for non-compliance.

Looking ahead, the property market faces uncertainties, with rising interest rates posing challenges for buy-to-let landlords. Despite market volatility, equities have historically proven a more rewarding investment over the past decade, underscoring the importance of a diversified investment strategy.

Pros and cons of investing in real estate

The pros

Traditional real estate investments typically fall into two main categories: residential and commercial properties. Residential properties include homes, rental properties, and the practice of buying and selling homes for profit, known as flipping. On the other hand, commercial properties encompass apartment complexes, office buildings, and retail spaces like strip malls.

Investing in real estate offers straightforward concepts that are easy to grasp. While the process of buying a home can be intricate, the fundamental principles are uncomplicated: Acquire a property, oversee maintenance (and tenant management, if applicable), and aim to sell at a higher value. Additionally, owning a tangible asset can provide a sense of control over your investment compared to purchasing shares of stocks in companies.

Utilizing debt, commonly referred to as a mortgage, in real estate investment is typically considered safer. With a down payment of 20% or less, you can invest in a new property and finance the remaining cost. Conversely, investing in stocks with debt, known as margin trading, is considerably riskier and is generally reserved for experienced traders.

Real estate investments often act as a safeguard against inflation. Property ownership is commonly viewed as a hedge against inflation, as both home values and rental income tend to rise in tandem with inflationary trends.

Property ownership can also offer tax advantages. Homeowners may qualify for tax deductions on mortgage interest payments for up to $750,000 in mortgage debt. Furthermore, selling a principal residence may allow individuals to exclude capital gains taxes on proceeds up to $250,000 for singles or $500,000 for married couples filing jointly. Commercial property owners may utilize strategies like a 1031 exchange to defer capital gains taxes by reinvesting proceeds in similar properties. Additionally, investment properties can benefit from tax breaks through depreciation, allowing owners to deduct wear and tear expenses.

The cons

Real estate investments come with their fair share of drawbacks compared to stocks. Firstly, managing properties, particularly rental ones, demands significant effort and time, unlike the relatively passive nature of stock investments like mutual funds.

Moreover, real estate entails substantial upfront costs and is relatively illiquid. Selling property involves more complexities and time compared to the seamless buying and selling of stocks.

Transaction expenses associated with real estate are notably high, with closing costs often amounting to 6% to 10% of the sale price, contrasting sharply with the minimal fees charged by most brokers for stock trades.

Diversifying real estate investments is challenging due to the emphasis on location. Property values can fluctuate significantly depending on the region, making it difficult for investors to spread their investments across different areas and property types without substantial resources.

Lastly, while real estate prices generally appreciate over time, there’s always a risk of selling at a loss, as evidenced by events like the 2008 financial crisis and the housing market uncertainties following the recent pandemic. This element of uncertainty mirrors the risks inherent in stock investments.

Pros and cons of investing in stocks

The pros

Stock investments offer notable advantages over real estate, primarily in terms of liquidity and ease of diversification. Unlike real estate, which can tie up investment cash for extended periods, stocks allow for instant buying and selling, providing investors with more flexibility and control over their investments. Additionally, the value of stock investments is readily accessible, offering greater transparency compared to real estate valuations.

Diversifying an investment portfolio is simpler with stocks, as it requires less time and capital compared to real estate. While acquiring a diverse range of properties across various locations and industries can be challenging and costly, stocks offer the opportunity to build a broad portfolio effortlessly. Investing in mutual funds, index funds, or exchange-traded funds enables investors to gain exposure to a wide array of companies and sectors efficiently, facilitating instant diversification.

Moreover, stocks generally entail fewer transaction fees, with many brokers offering commission-free trading options. The competitive landscape among discount brokers has led to reduced trading costs, making it more cost-effective for investors to buy and sell stocks. Additionally, tax-advantaged retirement accounts, such as 401(k)s and individual retirement accounts (IRAs), provide opportunities for tax-deferred or tax-free growth of stock investments, further enhancing their appeal as long-term investment vehicles.

The cons

Stock prices exhibit higher volatility compared to real estate, with fluctuations occurring at a faster pace. This volatility can be unsettling for investors, particularly those with a short-term outlook. However, adopting a long-term investment strategy, focused on buying and holding stocks and funds despite market volatility, can help mitigate concerns associated with price fluctuations.

Selling stocks may trigger capital gains tax obligations, depending on the duration of ownership. Stocks held for more than a year may qualify for lower tax rates on capital gains. Additionally, investors may be liable for taxes on stock dividends received within the tax year. Understanding the tax implications of stock transactions is crucial for managing investment returns effectively.

Emotional decision-making often influences stock trading behavior, especially during periods of market uncertainty. While buying and selling stocks is relatively straightforward compared to real estate transactions, investors should exercise caution to avoid making impulsive decisions. Adopting a disciplined, long-term approach to stock investing can yield more favorable outcomes, emphasizing the importance of maintaining a balanced and diversified investment portfolio.