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Buy-to-let returns are deteriorating. Here’s why I’d invest in the FTSE 100 instead

With house prices continuing to move higher in recent years, the gross yields available on buy-to-let investments have been declining. While this may be good news for existing property investors who have benefitted from capital growth, individuals who are new to the industry may now face relatively unappealing income yields.

Furthermore, there are a number of costs which could increase over the medium term. For example, void periods may lengthen, and rental growth may be limited by the uncertain outlook faced by the UK economy. Alongside tax changes, they could further reduce an investor’s net income yield.

In contrast, investing in the FTSE 100 through a tax-efficient account such as an ISA or a SIPP could generate significantly higher net yields than are available on property at present.

Lower income returns

As mentioned, the gross income yields on property have fallen over the last decade in many parts of the UK. That’s simply due to continued house price growth after the financial crisis, with rental growth unable to keep up with it in many areas.

Looking ahead, new investors in the buy-to-let sector may be faced with lower gross yields at a time when the cost of owning a property for investment purposes is increasing. The end of tenancy fees could mean they’re simply passed on to landlords in the form of higher monthly fees. There’s also the potential for a rising interest rate, which could further squeeze net yields.

The UK economy also faces an uncertain outlook at present. This may mean that void periods are longer than they have been in the past, while rental growth could be subdued as a result of weak consumer confidence. And with tax changes meaning interest costs cannot be offset against rental income for a number of landlords, the potential to earn a worthwhile second income from property seems to be becoming increasingly limited.

Higher income returns

In contrast, the FTSE 100 is becoming increasingly appealing from an income perspective. If FTSE 100 shares are purchased through an ISA or a SIPP, their income returns are not subject to any form of taxation. This means the gross yield on a stock is the same as the net yield for most investors. As such, with it possible to buy a range of FTSE 100 companies that yield over 5% at the present time, investors are able to build a portfolio that offers a significant second income.

While in the past products such as ISAs have had limited appeal for those wishing to invest large sums of money, the £20,000 annual allowance is likely to be sufficient for a range of investors. As such, and with it being the start of a new tax year, now could be the right time to focus on building a portfolio of large-cap income shares, rather than obtaining a relatively low net yield from buy-to-let properties.

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