How buy-to-let could support your pension income
Find out how property can provide for your retirement plans
Perhaps it is the result of too many games of Monopoly at Christmas, where just one opponent landing on your Mayfair house can set you up for life, but becoming a landlord often seems like a very attractive prospect to British savers.
That’s particularly true for those of us who have already been around the board a few times. With the state pension age rising, and ‘gold-plated’ final salary pensions largely a thing of the past, many of us need to work out a combination of options for funding our later years.
What’s the deal?
According to a survey from estate agents Ludlow Thompson, there are currently 2.5 million buy-to-let landlords in the UK , and the relative certainty of monthly income is exactly what many retirees are looking for to supplement their state pension. Many are also tempted by the tantalising possibility that the value of the property they are renting out might rise too, meaning further gains when they come to sell up.
Figures from the Office of National Statistics show that 29% of people believe that property is the safest way to save for retirement, second only to saving into a company pension, which indicates just how popular bricks and mortar have become.
One of the reasons that buy-to-let is popular is that most of us find it easier to understand than other forms of investment such as funds and shares. Property, after all, is part of everyday life. However, being a landlord is more complicated than it first appears. It pays to do the sums first to check whether the investment is going to deliver the income that you expect.
Why high rents look tempting
If you have been looking in the local letting agents’ windows, becoming a landlord might look like an easy route to riches. The average rent in the UK is £798 a month excluding Greater London, while in the City of London it’s over £2,000, according to figures from Rightmove. City of London rents are up nearly six per cent in a year, while outside Greater London it is just under three per cent.
While the supply of new houses being built has not kept pace with rising demand and with many tenants often chasing every available property, landlords across the UK have been able to put up rents. Even though Brexit will create uncertainty for the economy, experts expect that rental growth will continue to grow. In fact, the Royal Institute of Chartered Surveyors (RICS), is predicting a two per cent increase in rents in 2019.
With predictions like these, it is unsurprising that those who are worried about how inflation might ravage their retirement savings might consider buy-to-let a good bet.
Instead of just looking at the monthly rent in estate agents’ windows and speculating on how to spend it, prospective landlords should compare the amount of income they might receive from a buy-to-let property to the amount they would receive from another pension investment.
One way to do this is to use a measure called the yield. The gross yield is simply the amount of rent you receive annually for a property, divided by the price you paid for it, and then multiplied by 100 to give a percentage. For example, if you bought a property worth exactly the UK average of £231,000 and then rented it out for the UK average rent of £798 a month, the yield would be 4.1%. But remember, if you don’t own the property outright and you have a mortgage loan on it, then your return will be impacted as you’ll have interest (and potentially other fees) to pay on the amount you borrowed.
Nevertheless, this is likely to compare favourably with the interest rate you would receive if you put your savings in the bank and then withdrew an income from that.
However, if you are looking at investment, the results are less clear cut. If you had invested your money in the FTSE 100 Index for the past five years (2014 to 2018) and reinvested your dividends, your money would have increased by 3.9 per cent each year over the period. That means for the £9,576 you could have made each year in our property scenario you’d have made £9,000 if you had put the same amount of money into a FTSE 100 tracker fund. And nobody from the FTSE is going to be calling you in the wee small hours complaining about a leaky boiler, which some might consider compensation for a slightly lower return.
Whether your cash is in stocks and shares or in bricks and mortar, the value can go up as well as down, so you need to be prepared in either event.
The true cost of buy-to-let
The gross yield on a property does not take into account any of the considerable costs that can be associated with a buy-to-let property. Unless you are lucky enough to have bought a property outright, this includes the cost of mortgage payments. Although interest rates are low, buy-to-let mortgages are more expensive than their residential counterparts, and many come with high arrangement fees. As well as the cost of paying your mortgage, you will have to calculate the cost of maintaining the property, ground rent and service charges (if it is a leasehold property) and letting agency fees.
Your property is unlikely to be occupied the entire time either, so you will need to make allowances for what are known as ‘void periods’ – times when the property is empty and you are not receiving any rent. Taking these costs into account can bring your yield down considerably.
Talking about tax
No-one likes to think about the taxman when they’re considering their nest egg, but it is vital to consider the tax implications of being a landlord when weighing up the pros and cons. Unlike other forms of retirement investment, you cannot hold buy-to-let property in tax-efficient wrappers such as an ISA, so the tax you pay on your buy-to-let property can be considerable.
The government’s efforts to cool down the buy-to-let market have increased the tax burden. If you already own a home, you now pay three percentage points extra of stamp duty when buying a second residential property.
The government also changed the rules on mortgage interest, so you are no longer able to reduce the tax bill on your rental income by offsetting all of the mortgage interest you pay against it. The amount you can offset is being gradually reduced before being replaced with a 20% basic rate tax reduction in April 2020, meaning that all higher rate taxpayers will be worse off.
However, you are still allowed to deduct other expenses, including letting agent fees, maintenance and the replacement of some domestic items . If you sell your buy-to-let property for more than you paid for it, you may also have to pay capital gains tax on the disposal.
Weighing up the options
It is easy to see why buy-to-let is a popular strategy for those thinking about retirement. The possibility of regular monthly income that rises with inflation, combined with the possibility of capital gains if house prices continue to rise is enticing. In addition to this is the possibility of leverage – if you borrow money to buy a property, and it rises in value, you get all of the gains – and the deal looks more attractive.
However, it is also worth understanding that while gains on property are magnified if you borrow, losses are magnified too, while becoming a buy-to-let landlord can also take up time and energy that you may be unwilling to give later in retirement.
It is important to consider all of these factors before deciding whether becoming a landlord is the best way to achieve your retirement objectives. After all, more than one game of Monopoly has ended in tears.
Before making financial decisions always do research, or talk to a financial adviser. Views are those of our mentors and customers and do not constitute financial advice.