The Motley Fool

Forget buy-to-let…I’d buy FTSE 100 income stocks instead!

Even after sweeping reforms over the last couple of years, buy-to-let (BTL) remains a popular investment strategy here in the UK. But while it’s possible to achieve higher rental yields in certain areas of the market, the average UK yield is now below 5%.

In my opinion, BTL lacked investment appeal even before these reforms, especially if funded by a mortgage. Most BTL mortgages are interest-only, and with average fixed-rate mortgages charging interest of around 3%, this means that a landlord borrowing 50% of a property valued at £200k, would end up paying £3k a year in interest payments. If the rental yield is 5%, then these mortgage payments would reduce the net yield to just 3.5% — hardly impressive.

What’s more, with an interest-only mortgage, landlords must repay the whole principal amount, at the end of the mortgage term. This means that either the landlord must have additional funds, or must sell the property to make the repayment. In many cases, landlords are reliant on house prices appreciating in order to make any sort of return from their investment.

Lower returns and higher risk

New rules brought in to rein-in the BTL market have now reduced returns even further. Landlords must now pay an additional 3% stamp duty on any second property, regardless of its value so they have lost the previous zero rate stamp duty band, which applied to the first £125k of a property’s value.

The additional stamp duty now means that in many cases – for those landlords with mortgages – rental income will not cover the combined cost of interest payments and stamp duty, in the first year.

Changes to mortgage tax relief and the removal of the wear and tear allowance have put even more strain on rental yields. In the current market, I think you’d do well to achieve a net yield of 3%.

Another problem I have with BTL is that it lacks diversification. With property values being so high, investors must part with a significant amount of cash, just to buy one property. In many cases, each BTL investment represents a considerable chunk of an investor’s wealth. Any problem with the property or tenants poses a serious risk to the landlord’s return. Diversification is only possible for those landlords with millions to spend.

High-yielding dividend stocks

To my mind, investing in the stock market is a lot more attractive. Not only is it possible to achieve a much better degree of diversification, with lower amounts of money, but it’s also possible to find higher income yields from dividends.

In fact, at the time of writing, around 35% of all companies listed on the FTSE 100 offer a dividend yield of 4% or greater. Notably, investors receive this dividend without having to pay for costly home repairs, deal with difficult tenants, or advertise with lettings agencies.

Many of these high dividend-payers are huge global brands, operating in multiple product and geographical markets, providing the kind of diversification that landlords can only dream of.

House prices are expensive by historical standards. The FTSE 100 on the other hand, still looks cheap to me, and I think its prospects are better too.

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