Why you should invest your pension money into property

Property as a pension investment has crushed shares

If you visit a financial advisor to discuss your retirement plans, the chances are that residential investment property won’t be mentioned. You can call me a cynic, but my best guess why your financial advisor won’t even broach the subject is that there is little to nothing in it for him.

Here I look at how a property investment would have fared over the last 20 years, and compare it to the FTSE 100 Index over the same period. I then summarise the benefits of property investment for retirement goals over the traditional shares investment.

Shares have performed well

The benchmark shares index in the UK is the FTSE 100. Its constituents are the top 100 companies in the UK by market size. Regarding market coverage, the value of the FTSE 100 is around 70% of the total value of the UK stock market.

On the 1st January 1987, the FTSE 100 Index closed at a level of 1808.30. As I write this investment blog post, the FTSE 100 Index is around 6850. If you’d put £50,000 into the FTSE 100 on January 1st , 1987, your investment would now be worth £189,404. That’s an average return of 4.5% per year.

Property investment performance has been stellar

At the end of 1986, the UK House Price Index as measured by Nationwide stood at 79.0. At the end of the third quarter 2016, the index was valued at 411.60. A property investor who had invested £50,000 in UK property at the beginning of 1987 would now be sitting on a property investment portfolio valued at £260,506. That’s an annual growth rate of 5.7%.

Pension saving has tax advantages

One of the ‘disadvantages’ that your financial advisor will tell you about residential property versus shares is that when you invest in shares in a pension, all your growth and dividends will be tax-free. You also invest ‘net’ of tax – so your investment is grossed up. In other words, had you been able to invest that £50,000 in a pension plan back in 1986, your actual investment would have been grossed up to £62,500.

The financial advisor will quite rightly point out that your £50,000 investment in the FTSE 100 Index would have grown to around £236,755 – still below the property investment, but not such a huge underperformance.

Property investment benefits from leveraging

To make that £50,000 investment into shares in 1986, the investor had to have £50,000 to invest. The property investor could have used a mortgage to invest. So, let’s say that the investor took advantage of a 75% buy-to-let mortgage. Their original investment of £50,000 would have bought a property valued at £200,000. Today, the investor’s property portfolio – based on the UK average house price – would be worth £1,042,025. That’s a colossal average annual return of 10.6%.

Reinvesting dividends

In the above example, I’ve discounted rental income as paying the mortgage. (I’ve also discounted the fact that the rental income would now cover the mortgage about five times!)

If you had reinvested the dividends from the FTSE 100 over the 30 years, your share portfolio would have performed better. Over the last 30 years, the average dividend yield on the FTSE 100 has been 3.8%. With all of these dividends reinvested, your FTSE 100 portfolio would now be worth around £631,100. It's not bad for an initial investment of £50,000, but nowhere near the £1,042,025 that the property investor’s portfolio is worth.

Effectively, using the rental income to pay the mortgage is the same as reinvesting dividends on a shares portfolio.

Ah, but the tax….

Here’s where the financial advisor will bring tax into the equation. There’s always a tax. He will quite rightly point out that an investment in a pension vehicle allows your money and any income earned on it to grow (almost) tax-free. So, the FTSE 100 pension pot that has grown to £631,100 is free of tax while it remains in the pension scheme. You can also take 25% of this tax-free – if you want more, you could be charged 55% tax.

Let’s say you don’t want to take any of this, but only want to use it to create an income. Traditionally you’d buy an annuity, which would provide around 5% income – or £31,550 per year.

If you were to sell your property portfolio, you would incur capital gains tax. Let’s say that you’re a basic rate taxpayer. The CGT payable would be 18% of the gain – in this case 18% of ((£1,042,025 – £150,000 (the mortgage)) – £50,000) = £151,564. The net remaining would be £740,461 – still more than £100,000 more than the value of the FTSE 100 portfolio in a pension plan.

The big advantages of property as a pension investment

By investing in property, the investor above amassed a portfolio with a value of more than a £1 million. He’s also got some distinct advantages over the shares investor. This include:

  • With the average rental yield of 5.25%, the investor would now have a gross income of £54,706. After property management costs, the mortgage payments, and other expenses, the investor would be left with an income of around £36,000 per year – around £5,000 more than the FTSE 100 investor.
  • The property could still grow in value – the pension fund that has been converted to an annuity is frozen.
  • Rental income will continue to grow over time, helping to protect the investor from the effects of inflation. The shares investor could buy an annuity that offers increasing income but would have to accept a lower income to start.
  • If the property investor dies, the property he owns will be bequeathed to his estate. When the recipient of an annuity dies, in most cases the annuity will die with them.

With all these benefits, and a history of better investment performance than the stock market, isn’t it time you considered whether you should invest in property to achieve your long-term financial goals?

Contact one of our team on +44 (0)207 923 6100 to book an appointment today. We’ll be pleased to explore how property investment could help you achieve your goals.


Ryan Rahnavard
Associate Director

Ryan Rahnavard
December 11, 2016

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