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Forget buy-to-let! I think FTSE 100 dividend shares can offer a higher passive income

With the FTSE 100’s dividend yield standing at around 4.5%, it could offer a higher income return than a wide range of buy-to-let investments. Furthermore, when costs such as property management fees, taxes and void periods are factored in, the passive income potential of buy-to-lets becomes even less favourable compared to the FTSE 100.

As such, now could be the right time for investors to switch their focus from buy-to-lets to UK-listed income shares that offer higher returns, as well as lower risks.

Buy-to-let returns

With house prices having risen significantly since the financial crisis, it’s becoming increasingly difficult to obtain a high yield in many parts of the UK. House prices versus average incomes are towards the upper end of their historic range, which means that yields have been suppressed across the UK. While buy-to-let investors can still obtain a gross yield that’s in excess of the FTSE 100’s dividend yield in some places, in others this is becoming far more challenging.

The task of obtaining a high income return from a buy-to-let is made even more difficult by the myriad of charges that are levied on a landlord’s rental income. They include service charges (which can be exceptionally high on new-build properties), as well as estate agent management fees.

Buy-to-let investors must then factor in the possibility of void periods, as well as the rising taxes that are being levied on landlords. While many investors could previously offset their mortgage interest costs against rental income, this may no longer be possible in many cases. As such, a 4-5% rental yield can diminish surprisingly quickly when the costs facing landlords are factored in.

FTSE 100 returns

By contrast, the income generated from FTSE 100 shares has no deductions once it is paid into an investor’s ISA. As such, the index’s 4.5% yield is far more appealing than the passive income potential offered by the buy-to-let sector.

Furthermore, the index appears to be undervalued at present. It trades at a level which isn’t significantly different from where it was two decades ago. This suggests it may offer a wide margin of safety, and could deliver improving returns in the coming years.

Since the majority of the FTSE 100’s income is generated outside of the UK, it may be able to capitalise on a bright outlook for the global economy. Although a trade war could act as a drag on the world economy’s GDP growth rate, countries such as China and India have annualised GDP growth forecasts of over 6%. They could, therefore, act as catalysts on the wider world economy, as well as on the FTSE 100.

Generating a passive income from the FTSE 100 appears to be easier and more worthwhile than undertaking a buy-to-let investment. As such, now could be the right time to focus on shares, rather than property.

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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.