12 Sep 2016
Author: Stephen Breen
Which offers the best investment?
There is a divide between those who believe pensions are the best investment for retirement, and those who believe property is where your money should go. The Bank of England’s Chief Economist Andy Haldane recently said that property was the best investment – a remark that was branded irresponsible by Ros Altmann, Pensions Minister from May 2015 to July 2016.
Andy Haldane previously criticised pensions in May of this year as being too complicated, saying he was not able to make the remotest sense of them. But the slow uptake on pensions, despite the Government’s attempt to persuade people to save – indicates that many would agree with him. The buy-to-let property market, by contrast, appears to be thriving, with lenders anticipating funding 150,000 new investments in 2016 – a 20% increase on the previous year.
The idea that investment in property will lead to a good return certainly makes sense at first glance. Over the past 10 years, the increase in the average house price has been 42%. The fact that property is a geared investment can also be a huge attraction. Gearing (or leveraging, if you’re an American) simply means borrowing to support an investment. A buy-to-let investor with £100k to invest could purchase a single property for £100k without a mortgage, or four properties each worth £100k, taking a £75k mortgage for each purchase. If all of the properties increase in value by 10%, your profits would be £10k if you only bought the one property or £40k if you bought four. Provided that the cost of owning the property is less than the rent you achieve from it, your cash flow will be higher if you invest in the four properties rather than just the one. You’ll also be able to grow your portfolio of properties more quickly.
However, there are risks to geared investments. You may be unable to find a tenant for part of the year, or have to pay out unexpected maintenance costs. Even with tenants, you may not collect the rent if they default. Mortgage interest rates can rise after any fixed period you have agreed. There is also a risk that the property might decrease, rather than increase in value. Although historically property prices have risen long term, investors need to be prepared for the possibility of short term losses and have a contingency fund to ensure they can always pay their debts and expenses.
In addition to those risks, most people will significantly underestimate the true cost of property ownership, according to investment group Nutmeg. As an example, if you purchased a house for £500,000 you’d need to sell it for at least £700,000 to break-even 10 years later, factoring in the mortgage interest, stamp duty, insurance and other costs. Nutmeg point out that while property prices in the UK have risen by over 700% in the past 30 years, a medium risk portfolio would also have risen by 1,500% over the same time period (Source: ‘Should you invest in property or stocks and shares?’ Nutmeg)
Property investment has also suffered its fair share of ‘meddling and greater complexity’ in recent times. The higher stamp duty charges for second homes / investment properties and the cuts to mortgage tax relief due to come into effect in April 2017 have all made investment in property a less attractive prospect.
Paying a percentage of your salary into a pension has its advantages, compared to investment in property. Head of Retirement Policy at Hargreaves Lansdown Tom McPhail says it is a “simple, slightly boring” approach that works. If you are enrolled on a company pension scheme, you’ll not only be making your own contributions but you’ll benefit from your employer’s contributions as well. In addition, you’ll get a top up from the Government in the form of tax relief. Pensions grow tax free and you can take up to a quarter of the money without paying tax when you cash in your fund. You can also spread your risk – even if you have a relatively small pot to invest.
With so many obvious advantages – and with property investment beyond reach for many – it is surprising that the number of people contributing to a pension plan (according to the Office of National Statistics) has fallen in recent years, if you remove the effect of auto enrolment. One possible reason is that you cannot access funds until your 55th birthday. Tying up money for such a long period of time, even if it looks like the best investment in the long term, may not feel like the best option for many. There is also a perception that pensions are complex which has been exacerbated by recent changes such as the curtailing of annual and lifetime investment allowances, and the attacks on pension tax reliefs for the highest earners. The Government is aware of these issues and has drawn up proposals to allow people to withdraw £500 from their pension tax free in order to pay for pension advice.
So, pensions or property…?
Everybody’s circumstances are different and it makes sense to talk through your own with an expert before making your decision. In many cases, a balanced portfolio of investments is advisable. Although pensions are easily accessible, there are other ways of investing in property besides buying a house outright. Speak to our property team to find out more.