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How I’d beat the income returns on buy-to-let property with FTSE 100 dividend shares

It has become increasingly difficult for income investors to generate a high return on buy-to-let properties. This is partly due to rising house prices that have largely outpaced rental growth in many parts of the UK, thereby reducing yields. Furthermore, increasing taxes have produced net returns that are significantly lower than gross yields for many property investors.

By contrast, the FTSE 100 offers an above-average income return at the present time alongside its dividend growth potential. With tax-efficient accounts such as SIPPs and ISAs being available with low costs, now could be a good time to obtain a higher net income return with shares.

Difficult outlook

As with any income-producing asset, a higher price can mean a fall in yield. This has taken place across the buy-to-let sector over the last decade, with low interest rates contributing to rising demand for property. Alongside this, an uncertain future for the wider economy has caused rental growth to lag house price growth in many regions. The end result is lower gross yields in many cases, with it being difficult to obtain an income return of over 4% in some parts of the UK.

Alongside this, there seems to be a political consensus on helping first-time buyers to get on the property ladder. This has contributed to rising taxes for property investors, with changes such as stamp duty on second homes and an end to mortgage interest relief causing the net returns for landlords to be significantly lower than their gross returns in many cases. This trend could continue over the coming years as a lack of housing supply puts political pressure on landlords.

Growth prospects

As well as a 4.5% dividend yield, the FTSE 100 could offer income growth over the coming years. Its track record of dividend growth shows that it has the capacity to beat inflation on a regular basis, with its increasingly diverse range of businesses and geographies arguably making this more likely over the long run.

Alongside dividend growth potential is a net return which, for many investors, is the same as their gross return on FTSE 100 shares. Products such as a SIPP or a Stocks and Shares ISA are relatively cheap to open and administer, while their tax advantages can make them highly appealing to any income investor. And, with their annual allowances being relatively generous, they are likely to prove sufficient for most investors to generate a sizeable passive income from their capital over the long run.

Future changes

Of course, house prices could move higher over the coming years if interest rates persist at low levels. But from an income perspective, buy-to-let investment appears to be a rather unfavourable means of obtaining a passive income compared to the FTSE 100 at a time when the index offers a potent mix of a high yield and dividend growth potential.

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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.