Financial Planning update: Buy-to-let vs stocks and shares

Published: Tuesday 16 November 2021

Over the last couple of years, despite the COVID-19 crisis, the property market has been thriving, having been fueled by the stamp duty holiday, people reassessing their living arrangements and increased saving during the pandemic.

Buy-to-let properties have historically been a popular part of people’s portfolio, but how do they compare to stocks and shares and are they still a viable option?

Taxation

Recent changes to the taxation of buy-to-let investing have resulted in a set of measures that can discourage many from investing:

  • If you buy a property in addition to your main residence, you will pay an extra 3% in stamp duty (or 4%, based on the equivalent regimes in Wales and Scotland). This is in addition to the normal rates.
  • You can no longer offset your higher rate tax liability against mortgage interest. Relief on interest is limited to basic rate only.
  • If you sell a rental property, you will pay a higher rate of capital gains tax than you would for other types of investment. Basic rate taxpayers will pay 18% on gains realised, while higher rate taxpayers face a bill of up to 28%.

On the other hand, stocks and shares are subject to the following tax treatment:

  • Stamp duty of up to 0.5% in total, depending on the type of investments you buy.
  • Dividend income is taxed at lower rates than other investment income, as the companies have already paid corporation tax. You can receive £2,000 in dividends before paying any tax on this income.
  • Capital gains tax is charged at a rate of 10% for basic rate taxpayers and 20% for higher rate taxpayers. You can also sell your investment over a period of years, or transfer part of it to a spouse, to reduce, or even eliminate any tax liability.
  • Additionally, you can wrap your investments in a Stocks and Shares ISA, meaning you will not pay any tax on income or gains.

As you can see from the above, buy-to-let investors can end up paying significantly more tax in comparison to stocks and share investors.

Borrowing

With buy-to-let properties, like any property, you are encouraged to take out a mortgage to fund the investment. This comes with the risk that if the value of the property were to fall, then you could end up with a debt greater than the value of the property and owing the lender more than the property is worth.

Most rental properties are purchased using an interest only mortgage, with the premise of this being that the rental income covers the interest payments on the mortgage, and then when the property is sold (hopefully at a capital gain) then the capital element of the mortgage is also repaid.

Capital growth

According to Nationwide’s House Price Index Calculator, if you bought a property five years ago for £200,000, it would be worth £237,672 today. This represents a growth of 18.84% on your investment. In certain parts of the country, however, house prices have risen dramatically more than this, releasing even greater capital returns.

In comparison, the mixed investment 40% - 85% shares benchmark, consisting of over 4,000 mixed investment funds, has returned 40% over 5 years.

Past performance shows that generally, a balanced portfolio will produce a higher level of capital growth than property over the longer term.

The 'right' property could outperform the 'wrong' fund, but the odds are not stacked in favor of this.

Income yield

One of the main attractions of buy-to-let properties is the income that is produces through the collection of rent. This can be a nice way of topping up your monthly income and, when also taking into account capital growt, makes the total return comparable to that of a stocks and shares portfolio. 

However, it is important to consider the costs of owning a buy-to-let property and taking these into account when considering returns versus those of a stocks and shares portfolio. Buy-to-let properties come with additional costs such as insurance, mortgage payments and maintenance and this is not considering potential void periods or any emergency works that may need to be carried out on the property.

It is also worth bearing in mind the advantage of accumulation units within a stocks and shares portfolio – where any dividends produced are reinvested automatically and the income produced is re-invested. In comparison, it may take many years to accumulate enough rental income in order to save a deposit for your next buy-to-let property.

Liquidity

The main risk of a property investment is liquidity. Even when the market is performing well and is buoyant, it can take several months to complete a property sale, which is difficult if you need to access the money quickly.

Risk and volatility

Property tends to be less volatile than equities as an asset class, and the value of your property only matters when you are trying to sell it. It can, therefore, be a useful way to diversify your investment portfolio which is heavy with equities. The price of property will not always move in the same direction as equity prices and it can help to reduce the overall volatility of your portfolio.

It is also important to note that a rental property takes a lot of management and is effectively like running a business. This may suit some people more than it will suit others and you must have the time to deal with tradespeople, tenants and to cope with all the administration that comes with a rental property.

If you are considering a buy-to-let investment, you should:

  • Carefully research the property and the area.
  • Seek expert advice.
  • Make sure you have sufficient cash set aside to cover emergencies.
  • Invest in other assets so that you have diversification.
  • Avoid relying on property as your only source of income.

Please do not hesitate to contact a member of the team to find out more about your investment options.

Key contacts

Kyle Nethercott
Kyle Nethercott
Partner
View profile
Stephen Dick
Stephen Dick
Partner
View profile
Gary Cook
Gary Cook
Partner
View profile
Andy Hogarth
Andy Hogarth
Financial Planning Associate Director
View profile