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Buy-to-let vs the stock market – which is better?

Which is the better investment? Buy-to-let property, or the stock market? Finding an answer to this question isn’t straightforward. While it’s possible to quickly find out the returns investors have received via the stock market over the past 10, 20, or even 100 years, it’s quite challenging to find accurate returns for buy-to-let investing.

Returns vary on a case-by-case basis. London property investors have done particularly well over the past few decades. However, in other markets, they’ve struggled.

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Better returns

On average, the figures show buy-to-let investing has produced better returns over the past few decades. A study published in 2015 showed buy-to-let landlords enjoyed cumulative returns of 1,390% over 18 years from 1996, turning every £1,000 invested into £14,896.

This is based on both income and capital growth and assumes a property was acquired with a 75% loan to value mortgage. It represents average annual growth of 16.2% each year.

By comparison, including dividends paid to investors, the FTSE 100 has returned 7.8% per annum over the past 25 years. At this rate of return, every £1,000 invested in 1994 is worth £6,772 today.

Not a guide to the future

I don’t think it would be wise to use these historical figures as a guide to future performance. For a start, home price growth has slowed dramatically over the past few years. The average rental yield has also dropped as property prices have increased.

In the mid-90s, the average yield of rental properties in the UK was around 8%. Today, it’s below 5%. Also, the government has removed the lucrative tax breaks buy-to-let investors used to enjoy on mortgage costs. As a result of these changes, many landlords expect to make a loss over the next two years as they readjust their portfolios.

All of these factors combined don’t indicate a sunny outlook for buy-to-let, and that’s why I believe the stock market will be the better investment for the next few decades.

The better buy

As noted above, the FTSE 100 has produced an average annual return of 7.8% over the past 25 years. But it’s not just this high single-digit return that interests me. It’s also the diversification the index offers.

Buying a single rental property concentrates all of your wealth in one asset. On the other hand, when you buy the FTSE 100, you’re investing in 100 of the largest companies in the world. These have diversified income streams with more than 70% of profits coming from outside the UK. What’s more, you can own a FTSE 100 tracker inside an ISA, so you don’t have to worry about tax changes or charges. All you need to do is buy and forget.

You can also invest in property via the stock market with real estate investment trusts. You can do this with just a few pounds and, at the moment, some of the biggest trusts in the UK offer dividend yields of more than 5%.

This return is slightly above the average rental yield on offer in the buy-to-let market. That’s why my money is on stocks, not property, for the next 10 years.

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Rupert Hargreaves owns no share 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.