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Forget buy to let! I’d buy high-yielding FTSE 100 shares in an ISA today

With house prices having risen significantly over the last decade, it may be challenging to obtain a significant income return on buy-to-let investments. After all, in many regions the pace of rental growth has failed to keep up with house price growth, which has caused a suppression of yields in many cases.

By contrast, the FTSE 100 appears to offer a highly favourable income outlook. Many of its members currently offer dividend yields that are above the index’s 4%, with it being possible to build a diverse portfolio of large-cap shares that has an overall yield in excess of 5%.

As such, now could be the right time to focus your capital on high-yielding FTSE 100 shares. They could offer a greater overall return, and less risk, than buy-to-let investments.

Income profile

As well as yields in many parts of the UK housing market having fallen, landlords’ costs have also risen in a number of cases. In other words, the deductions that are made from a gross rental income to arrive at a net return have increased for many property investors. For example, tax changes mean that interest payments can no longer be offset against rental income in many cases. In addition, the end of tenancy fees means that management fees may rise for many landlords, while the prospect of a higher interest rate over the medium term could mean that landlords’ net returns are squeezed further.

By contrast, the FTSE 100 offers an income return that is in excess of its long-term average. As mentioned, a number of its members have high yields that could benefit from dividend growth due to their shareholder payouts being adequately covered by net profit. And with it being easier than ever to access tax-efficient accounts such as a Stocks and Shares ISA, the net return for FTSE 100 investors could be the same as their gross return.

Growth potential

Alongside the potential for a higher income return, FTSE 100 stocks also have capital growth potential. As an internationally-focused index, it may benefit from its exposure to fast-growing economies such as China and India. Furthermore, with the index having experienced a period of uncertainty over recent months, the valuations of many of its members may be rather low when their growth prospects are factored in. This could mean that they offer long-term capital growth potential to complement their income opportunities.

The buy-to-let industry, meanwhile, could struggle to post capital growth of a similar level to that achieved over the last decade. History shows that no asset rises in perpetuity without experiencing challenging periods. Since house prices are currently relatively high and consumer sentiment is weak, now could be the right time to focus on FTSE 100 income shares. Their valuations and growth prospects suggest that over the next decade they have a good chance of outperforming buy-to-let investments.

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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.