The prospects for the FTSE 100 may seem to be relatively downbeat at the present time, but the index could outperform buy-to-let over the long term. UK house prices may come under pressure as a result of weak consumer confidence, while tax changes and the potential for interest rate rises may squeeze profitability for a range of landlords. As such, with the FTSE 100 trading at what appears to be a favourable price level, it may offer stronger total returns than buy-to-let.
Perhaps a significant aspect of change for buy-to-let investors are modifications to the tax system. Previously, interest payments on mortgage debt could be offset against income received from renting-out a property. Now though, the government is gradually reducing this level for a range of property investors, which could cause their cash flow to worsen.
Additionally, a 3% stamp duty surcharge is being levied on second homes. Given that the average UK house price is now £225,000, this equates to £6,750. Assuming a 5% rental yield, this could mean that an investor essentially loses seven months in rent. And with other changes being made to capital gains tax, such as private residence relief, the overall picture for the buy-to-let industry seems to be deteriorating.
In contrast, the provision of products such as Lifetime ISAs and SIPPs helps to increase the potential returns that are available to investors in shares. It is possible for many investors to avoid a significant amount in tax when buying stocks, and this could make a huge difference versus property investing in the long run.
While interest rates are expected to rise at a relatively slow pace over the medium term, even a modest rise could squeeze the income of buy-to-let investors. With many property investors taking out interest-only mortgages in order to maximise their cash flow in the short run, their debt levels may continue to be high. This may mean that a small rise in interest rates slashes their cash flow. And since the prospects for the UK economy may be relatively uncertain at the present time, rent increases may not be as high as they have been in the past.
In contrast, the prospects for the world economy continue to be relatively sound. Emerging economies plus strong growth from the US appear to be boosting the outlooks of a wide range of FTSE 100 shares. This could lead to a recovery in the long run – especially since the index has a dividend yield of around 4.4%. This suggests that it offers good value for money and may have a margin of safety.
Although buying properties has been a shrewd move in the past, tax changes and an uncertain outlook mean that its appeal could slowly ebb away. At the same time, the appeal of the FTSE 100 following its recent pullback may have increased, and this could make it a stronger investment for the long term.
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Peter Stephens has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.