Buy-to-let is a popular approach to building a secondary income stream, yet investing in FTSE 100 shares might be more lucrative. In fact, over the last few years, property values and tax treatments have made it increasingly complicated for landlords to turn a profit.
Investing in the stock market has its own complications. However, the financial barriers to entry are significantly lower, the market liquidity level is much higher and, thanks to special trading accounts like a Stocks and Shares ISA, taxes also become irrelevant. Does this mean investing is the smarter option?
High property valuations
As of October 2022, the average UK house price reached £296,000. By comparison, it stood at £177,377 in October 2014, an annualised growth rate of 6.6%. That’s certainly nothing to scoff at, but it’s created a problem.
The average UK salary for full-time workers in 2022 stood at £33,000. Using the rough four times gross salary rule, most can’t get a mortgage beyond £132,000. So a large portion of the real estate market has become unaffordable. And the situation is made worse with interest rate hikes.
Needless to say, that’s a lot of money needed to get started. But when it comes to investing in FTSE 100 stocks, this barrier and requirement to take on debt don’t exist. What’s more, the UK’s flagship index has historically delivered average annual returns of around 7.2%. That’s only slightly ahead of the housing market. However, a 0.6% increase in returns over long time horizons can profoundly impact the wealth-compounding effect.
Liquidity vs volatility
Depending on the area, selling a house can be either quick or slow. And the increasing lack of affordability isn’t helping. On the other hand, the stock market allows instant trading. Investors can buy and sell shares without delay, making it incredibly easy to turn equity into cash.
However, this comes with a giant caveat – volatility. One major advantage real estate has had over stocks is short-term price stability. Panicking stock investors have a habit of selling en masse when economic conditions wobble. And even the stock prices of the strongest businesses can tumble in the chaos.
Between January and October 2022, during the height of the stock market correction, the FTSE 100 fell by nearly 7%. Yet house prices actually increased by around 8% over the same period. In other words, landlords were far better off.
FTSE 100 vs real estate
Historically, both asset classes have recovered from even the worst financial crashes before reaching new heights. That’s why both investing avenues remain extremely popular, despite all the horror stories that make media headlines.
However, if I had to choose between the FTSE 100 or a rental property, my money would go into the former. Apart from the previously mentioned advantages, the tax treatment is far more generous. When investing with a Stocks and Shares ISA, all capital gains and dividend income are tax-free. The same can’t be said with buy-to-let.
Capital gains tax on rental real estate is 8% higher than the standard rate, and rental income is taxed at 20%. Meanwhile, the new government budget is slashing capital gains tax allowances in half this April. With all that said, investing in the stock market seems like the more prudent approach to building wealth, in my opinion.
