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Here’s why I’d rather invest in the FTSE 250 than bothersome buy-to-let

“As safe as houses”… our love of home ownership is rooted in the idea that owning your own home provides certainty and security. So it’s not surprising that many Britons see buy-to-let property as the best way to invest our spare cash.

Unfortunately, the buy-to-let game has got a lot tougher over the last few years. High property prices, tax hikes for landlords and increasing amounts of red tape mean that it’s getting harder to generate attractive returns.

In this article, I’ll explain why I think the FTSE 250 mid-cap index could be a more profitable investment than rental property in the current market.

Is this a fair comparison?

Buy-to-let investors hope to make money in two ways. Each year, they hope to make a profit from rental income. And when the property is sold, they hope that it will have risen in value and will generate a capital gain.

An investment in a stock market index like the FTSE 250 is exactly the same. Dividends provide a regular income. And if the time comes to sell, you hope the index will have risen in value, providing you with a capital gain.

I think it’s fair to compare the FTSE 250 with housing. So how have these two different markets performed?

A clear winner

Here’s how the value of each market has increased over the last five years and since November 1996, the earliest data I could find:

Market

5-year gain

Gain since Nov 1996

Avg. house price (England & Wales)

+23%

+292%

FTSE 250 index

+29%

+354%

Capital gains: Both markets appear to have performed very well. But there’s a clear winner. The FTSE 250 has outperformed the average house price significantly over both timeframes. In terms of capital gains, the FTSE 250 is the winner.

Income: It’s much harder to compare the income credentials of each investment, as reliable information on historic property rental yields isn’t easily available.

However, I can say that the FTSE 250 currently has a dividend yield of 3.2%. For an index of mid-sized companies with a bias towards growth, I think that’s an attractive level of income.

Most landlords are likely to aim for a rental yield of more than 3%. But costs such as insurance, agency fees, repairs and void periods eat into rental income. Anecdotal evidence from friends who have buy-to-let property suggests to me that actual rental yields are usually under 5%, before tax. 

From what I’ve heard, anyone with a high loan-to-value mortgage may struggle to make any profit from rental income at all.

What I’d buy today

What I like about the FTSE 250 is that the companies in the index are large enough to be proven, profitable businesses. But they’re small enough to deliver strong growth, often for many years.

I also like the diversity provided by the index. If all your money is tied up in one rental property, then if things go wrong you can face big losses. If you’re investing in a group of 250 companies, then problems with one — such as the collapse of former FTSE 250 firm Sirius Minerals — will have very little impact on the value of your investment.

I don’t know what the future holds for the housing market or the FTSE 250. But in my view, an investment in a FTSE 250 tracker fund is likely to deliver satisfactory and hassle-free returns. That’s where I’d put my cash.

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Roland Head 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.