The income appeal of buy-to-let investing has been high for many years. Yields have fluctuated, but it’s been possible to generate an income return well ahead of inflation. And with demand for rental properties high, rents have generally increased at a brisk pace.
Now though, the buy-to-let market is undergoing a significant change. Restrictions on offsetting mortgage interest payments against income mean many landlords may see their net income growth come under pressure. Rising interest rates could also pose a threat to house price growth. And with Brexit risks, there may be better opportunities to generate a second income stream through FTSE 100 shares, in my opinion.
Changing industry
The prospect of higher interest rates could have a significant impact on UK house prices. In the last decade, investors have become used to low interest rates which have meant that the cost of servicing debt has also been low. Now though, interest rates are expected to gradually move higher over the next few years. This could squeeze landlords’ cash flow, with higher rents potentially being offset by higher mortgage interest payments.
The pace of rent increase may also slow to some degree. Brexit has contributed to weaker consumer confidence. Should Brexit create economic challenges, which are not guaranteed, it could lead to a period of lower rental growth which reduces the overall returns available within the property sector.
Of course, tax changes mean that restrictions on mortgage interest payments offset against income could hurt the appeal of buy-to-lets. The government is seeking to create a more level playing field between owner-occupiers and investors. As such, it would be unsurprising for additional tax changes to be made, which could further reduce the net yield on property.
Improving outlook
In contrast to investing in property, the stock market could become increasingly appealing from an income perspective. Diversifying geographically, or between different industries, is relatively straightforward, since it’s possible to buy a range of UK-listed and international stocks. Therefore, the risks involved in buying stocks could be lower than buy-to-let as the Brexit process moves ahead.
Higher interest rates may pose a threat to the performance of the stock market. However, with share prices generally being relatively low, there could be value investing opportunities on offer. For example, the FTSE 100 has a dividend yield of around 4.5% at present which suggests that, unlike property, it could offer a margin of safety. And since products such as an ISA or SIPP allow tax avoidance, the net income return from shares could be significantly higher than it is for property.
While share prices do fluctuate to a greater degree than property prices on a daily basis, the reality is that, over the long run, they may offer higher income returns. Alongside less effort on the part of the investor, this could mean that they’re worth buying instead of property at the present time.
