The British are renowned for their love of property. 85% of private tenants wish to own their own homes within the next 10 years, whilst 65% of Britons have bought the property they live in (in Germany, the figure is 43%).
The British love of property even leads many to ask whether it can be a viable source of retirement income. After all, if you can buy, say, three properties and settle the mortgages, you could then rent them out and live off the income. Yet how does this strategy compare to using pensions - the other popular way to fund retirement?
Property & retirement: an overview
Investors are often attracted to property because it is a “tangible” asset - you can see, touch and feel it, unlike stocks and bonds (which seem “immaterial”). Moreover, UK property has enjoyed a lot of growth over the years - despite slumps along the way. In 1980, the average UK house was £19,273; today, however, it stands at £274,000. Compared to even the stock market, this is an astonishing rate of capital growth.
Little wonder, therefore, that many are drawn to Buy to Let (BTL) as a potential way to fund their retirement. The common idea is to buy a property and use the rental income from your tenants to cover your costs. Whilst (hopefully) making a small profit along the way, when the mortgage is eventually paid off, you can enjoy the majority of the income for yourself. Given enough income, this could pay for a retirement lifestyle.
Issues to consider
All of this makes buy-to-let a compelling picture for many people. However, the big risk is that you have long periods of tenant absences. During the COVID-19 lockdown from March 2020, for instance, many BTL landlords struggled to gain tenants due to stringent quarantine and social distancing measures. Even many of those with tenants struggled to collect rent as people lost their jobs, but could not be removed from the property due to the Eviction Ban. In such a situation, landlords are forced to cover their BTL mortgages themselves.
For many in 2020, this was impossible. However, selling a BTL portfolio was also tremendously difficult since the housing market had come to a standstill. This highlights another risk with BTL; that direct property investments are more “illiquid” than many “intangible” investments, such as stocks and bonds. There is also no guarantee that you will make a capital gain on your property sale. If you take out a BTL mortgage and the property value drops below the loan value, then you could end up in negative equity if you need to sell.
These scenarios are difficult for those still working in their careers. However, for someone who relies on BTL in retirement - with little/no other income streams - they could be devastating.
Pensions & retirement
Comparing property to pensions is difficult. First of all, the latter is a financial “product” whilst property is not only an asset - but it is also, often, a home. Secondly, there are various pension types which can muddy the picture:
The first two types offer a significant advantage over property for retirement income. Whilst a property may depreciate or fail to provide rental income for certain periods, your State Pension (and a final salary pension, if you have one) will always provide an income until you die. This is enormously reassuring and provides stability.
A pension pot also has its own benefits. In particular, the UK government will “top up” anything you put into your pension pot(s) according to your highest rate of income tax. Your contributions are capped at £40,000 per year or 100% of your earnings (whichever is lower). So, for a Basic Rate taxpayer it only “costs” 80p to put £1 into their pension (20% relief), whilst for someone on the Higher Rate the cost is 60p. Over years of contributions, this adds up to huge, tax-efficient extra growth for your retirement fund when combined with the power of compound interest.
The main drawback from pensions is that your money will be largely invested. The stock market goes up and down, and there is a risk that your pension(s) may not last in retirement unless you plan carefully.
Suggestions for retirement planning
Ultimately your financial goals, current situation, investment interests and risk profile will play key roles in determining the role of pensions and/or property in your retirement plan.
For some, combining the two can be appropriate. Perhaps you could hold a second property providing a rental income, for instance, whilst also enjoying income from your State Pension and one - or more - pension pots.
One thing to bear in mind is diversification risk. With a second property, most people will need to allocate a large part of their wealth towards its purchase. If your plans do not work out, then this can lead to disproportionate loss compared to someone with a more “spread out” portfolio (i.e. across cash, shares, bonds and property funds).
Contact your adviser to discuss your retirement planning