Buy To Let Property v Global Equity Portfolio

Introduction

In this article, we’re going to look at the pros and cons of owning a Buy-To-Let (BTL) property compared to investing in a well-diversified global equity portfolio. This article is aimed at those who are considering buying a BTL property as either an investment or an additional source of income, perhaps in retirement.

I should point out that there are full-time professional property investors who are extremely successful in running a portfolio of BTL properties. They are often highly leveraged, have access to a team of builders and trades people and manage all aspects of the letting process.

Most people aren’t professional property investors and instead are looking for an investment that can provide decent returns and the one investment that we, in the UK, tend to obsess about is property.

So, if you have a lump sum to invest, should you invest in a BTL property or a global equity portfolio? Our global equity portfolio is going to be represented by the iShares Developed World Index Fund which aims to track the MSCI World Index, an index that comprises shares in companies listed on the largest of the world’s stock markets.

Let’s look at some of the factors you may want to take into account.

Costs

The costs involved for the average BTL property investor can seem daunting and can include:

Stamp Duty Land Tax which includes a 3% surcharge for those buying additional homes including BTL properties.
Mortgage fees, if applicable.
Surveyor costs.
Legal fees.
Insurance.
Maintenance costs.
Letting Agent fees.
Fees for complying with safety checks for gas, electricity as well as energy performance.

All of these costs will have an impact on the rental yield.

Let’s now look at the cost of holding the iShares fund and I am going to assume that the investor is also receiving comprehensive financial planning advice (which should encompass all areas of financial planning and not just investments). Generally speaking there are three types of fees that will apply:

Advice Fee – let’s assume a 1% fee for this.
Platform fee – this is an online platform where you can hold your investment. A typical fee might be in the region of 0.20%.
The actual cost of the investment. In this case the iShares Developed World Index fund has annual ongoing charges of 0.16%.

The total fee is therefore around 1.36%. I would point out that, if you are paying your financial adviser a fee of 1% per annum just to manage a portfolio of index funds, you might want to question what the adviser actually does for that fee.

In terms of costs, a global index fund is a lot cheaper than a BTL property.

Performance

For those owning a BTL property, the investment return comprises two key elements; the rental income and any increase in the price of the property.

These two elements are largely determined by where the property is located and it is this that often separates the professional BTL investor from the average BTL investor. For example, rental yields in some areas in the North of the UK have been attractive but property prices have remained relatively flat whereas in the South of the UK, rental yields have been less attractive but property prices have risen much faster.

Rental yields might also be determined by the type of property as well as the extent to which any building or remediation work needs to be done.

The typical BTL investor with one or two properties is likely to own property near where they live and is less likely to want to do any major renovation work.

It’s difficult to compare the exact performance of a particular property with our iShares Developed World Index fund so we’ll use the Halifax Property Index as a proxy. Over the last 10 years the performance has been as follows:

Halifax Property Index 56.50%
iShares Developed World Index Fund 214.82%

As you can see, an investor, over the last ten years, would have been much better off holding the iShares fund.

Volatility

The iShares Developed World Index Fund has achieved an annualised performance of around 12.15% per annum over the last 10 years, however, investors in the fund need to be prepared for a degree of volatility i.e. the fund can go down as well as up and that some of the falls can be significant.

For example, although outside our ten year performance range, the index fell by 57.46% during the financial crisis of 2007-2009.

Over the last ten years, the Halifax Property Index has largely seen a positive return although the second half of 2023 saw falls of around 4.60 – 4.70% on an annualised basis due to higher interest rates.

Diversification

Unless you have a large property portfolio, it is very difficult to diversify across different geographical locations or sectors. Most people will have one or perhaps two properties of a similar type in the same location.

If the type of property or particular location isn’t attractive then this can affect the capital value and rental yields.

The iShares Developed World Index fund, on the other hand is well diversified with 1,436 different holdings across 23 different regions in multiple sectors.

Liquidity

The settlement date for the iShares fund is the trading date plus 3 days. In other words, the fund can be sold and the cash showing on your investment platform within a few days.

It can take several months to complete on a property sale and receive the proceeds. If you needed to raise money, it could take a while to raise finance against the property assuming that a lender was prepared to do this.

Tax Wrappers

A residential BTL property can’t be held in a tax-advantaged wrapper such as a pension or ISA. As such, BTL landlords will have to pay tax on any rental income. Also, since April 2020, landlords cannot deduct the interest they pay on their mortgage before paying tax which gave higher rate tax payers 40% tax relief on their mortgage payments. Instead landlords get a flat rate tax credit of 20% on their mortgage interest.

When a BTL property is sold, any gains are subject to Capital Gains Tax (CGT), with the higher rate now 24%.

In contrast the iShares Developed World Index Fund can be held within a pension or ISA wrapper.

If you were a BTL investor and you found your ideal property to buy wouldn’t it be great if you could get a 20% discount on the asking price. Those investing in the iShares fund can effectively get a 20% discount because of the tax relief they will get on making contributions to their pension.

In addition, under current rules, the pension fund is outside of your estate for Inheritance Tax (IHT) purposes.

If the iShares fund is held within an ISA, all income and capital gains are tax free.

The Hassle Factor

This, for me, is perhaps the biggest drawback of holding a BTL property although for some this is the biggest attraction.

Owning an asset which requires you to potentially deal with unruly and demanding tenants, have to maintain it, for example, fixing the boiler, replacing the carpets etc. and keep on top of all of the legal compliance such as Gas and Electricity Safety Checks can be a huge hassle and eat into returns.

In contrast buying and selling the iShares fund can be done with a click of a button!

Financial Planning

Where we have clients with BTL properties we will take these into account within their financial plan and include them within different scenarios. For example:

It allows us to see the extent to which the rental income is contributing to their overall income needs.
Whereas the rental yield may seem attractive in the early part of retirement, the hassle factor may be a key consideration in the latter part of retirement and therefore can we replace the rental income?
If there is a capital gain, we can plan for this and determine how any potential tax liability may affect the overall strategy. We can then consider specialist investments such as Enterprise Investment Schemes (EIS) to defer any CGT liability if appropriate.
We can consider the BTL property as part of a wider Estate Planning strategy and how this impacts any potential IHT liability for the estate.
We can consider whether the BTL property could be gifted to family members or a Trust and any impact this could have. For example, gifting property to a child may mean they lose out on any first-time buyer incentives.

There are a many different ways that a BTL property can impact a client’s financial plan and it is important to have a financial strategy in place that takes this into account.

Conclusion

We do tend to have an obsession with property in the UK and we like the fact that it is something tangible that we can see but investors, generally speaking, have been better off investing in a portfolio of global equities. These are shares in companies that produce products and services that we use every day.

These shares tend to be more volatile than property and so it pays to have a financial planner on hand to avoid any knee jerk reactions when markets fall. Also, it pays to have a financial plan in place where the main objective is for you and your family to be able to live comfortably for the rest of your lives, whatever happens.