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Forget buy-to-let: I’d obtain a passive income with FTSE 100 dividend shares

Buy-to-let investments have often been viewed by investors as a means to generate a passive income. After all, a shortage of rental properties has meant that demand among tenants has generally been high, while rising rents and low interest rates have led to high net returns for landlords.

Now, though, the income investing prospects of buy-to-let could be relatively unappealing compared to FTSE 100 dividend shares. The index has a number of high-yielding stocks that could offer strong dividend growth, as well as tax efficiency when compared to a buy-to-let investment.

Buy-to-let income potential

The rise in house prices in the last decade means that the income yields on buy-to-let investments may be somewhat limited. Although rental growth has been strong, it has been unable to match house price growth in many areas. As such, investors may now only be able to obtain a gross rental yield of around 4%, with costs such as void periods and repairs being deducted from that figure to arrive at a net return.

Of course, tax changes have further limited the net return available to buy-to-let investors. Previously, landlords could offset mortgage interest payments against rent. However, that is now not possible for many landlords, which may lead to their net returns being even less appealing.

FTSE 100 income prospects

By contrast, there are around 25 FTSE 100 shares with dividend yields above 5%. Since the net return is the same as the gross returns for investors who buy their stocks through a Stocks and Shares ISA due to a lack of tax being levied, they may be able to obtain a higher income return from their portfolio than that which is available on a buy-to-let investment.

Furthermore, obtaining a passive income from FTSE 100 shares is simpler and less risky than undertaking a buy-to-let. The index offers a wide range of companies that operate in varied geographical locations and industries. Owning a number of them helps to reduce an investor’s reliance on one specific asset, which is the case with a buy-to-let. Additionally, buying and selling shares is a quicker and easier process than buying a property. It requires less upfront capital, as well as less time to manage your investments.

Outlook

Of course, property prices could continue to rise over the long run. A shortage of new homes means that demand may exceed supply, while continued low interest rates could act as a catalyst on the housing market.

However, when it comes to generating a passive income from your capital, the FTSE 100 may offer a higher return. It also has greater diversification potential, and is a simpler means to obtain a regular income from your hard-earned cash. As such, now could be the right time to switch your attention from buy-to-let properties to large-cap income shares.

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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.