I believe many investors would be better off forgetting about buy-to-let and looking at making a million by investing in property shares instead. Consider the costs, both in money and time, of buy-to-let. A sizeable deposit will be needed to secure a large mortgage, which has to be paid off. If a property is paid for with cash then there are still legal and surveying fees. Tenants have to be found, possibly regularly, and rental payments may have to be chased. Then the property has to be maintained and insured.
Compare all that work with opening an ISA online and investing in property shares at the click of a mouse. Share dealing in an ISA will attract transaction and account fees. However, the tax-free status of ISA accounts can sometimes offset these completely. So long as annual contributions to ISAs stays at or below £20,000 all dividends paid and all capital gains are completely tax-free. Buy-to-let income is taxed as are any gains made on selling the property.
Making a million is easier in a tax-free environment. A £20,000 investment that grows at 12% per year will take 35 years to hit a million. But take 20% of that 12% annual return away in taxes and it now takes 43 years to hit the £1m target.
We can’t talk about return without considering risk. A single buy-to-let investment really does put all your eggs in one basket. By investing in property shares the risk is spread across multiple properties.
The REIT way to make a million
So what are the options for making a million with property shares? Well, real estate investment trusts (REITs) are what I am thinking of. There are plenty to choose from. Unite Group manages a portfolio of student housing. Britsh Land Company and Land Securities Group are both very large commercial retail and office REITs. Tritax Big Box is a REIT that focuses on logistics facilities. By combining a number of REITs in an ISA an investor can get exposure to multiple properties with very different groups of tenants.
REITs are legally required to pay out 90% of their income as dividends to shareholders. These, often large, dividend payments are not taxed inside an ISA and can be reinvested. Reinvesting untaxed dividends alongside periodic contributions to an ISA can quickly grow the size of a portfolio. As the portfolio grows, larger and larger dividend payments are earned, which can be reinvested, and so on. This is the kind of compounding that can make a million-pound investment portfolio over time.
If a potential buy-to-let investor is searching for a steady income stream, I believe REIT investing might serve them better. The dividends paid by REITs can be drawn as income. With buy-to-let, losing your tenant means losing all your income. That’s not the case with an investment in a REIT. And when the time comes to cash in a REIT portfolio, the shares are sold, again with the click of a mouse in an ISA. Compare that with the rigours of selling a house.
In a simple comparison of the potential to make a million with REIT stocks versus buy-to-let, I would go for the REIT nine times out of 10, especially when combined with an ISA. I cannot overstate the significance of tax-free investing.
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James J. McCombie owns shares of British Land Co. The Motley Fool UK has recommended British Land Co, Landsec, and Tritax Big Box REIT. 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.