Build An Income With Stock Market ‘Bricks And Mortar’

As we learned on Budget day last Spring, from 6 April 2015 pensioners will be given unprecedented freedom to use their own money that they’ve saved up all their working lives as they see fit.
I know, “about time” was my first thought, too.
Apparently, such a radical notion amounts to a revolution. No wonder people were put off pensions!
Anyway, nearly a year on and nobody knows exactly how crazy the over-55s will go when they get their hands on the cash.
However, there’s talk that many will raid their pension pots to invest in buy-to-let property.

Age old question

Now, I understand why a pensioner might look to rental property for an income.
Annuity rates are rubbish: you can only put £10,000 in the long-awaited pensioner bonds, and the tiny income from gilts is a miserly reward for 40 years of doing your bit to run up the national debt.
Exactly how are these miniscule yields supposed to help a pensioner fund their appetite for Fisherman’s Friends, trophy mistresses or toy boys, and gadgets for the grandkids?
Pensioners, by definition, haven’t got all day to allow compound interest to do its thing like the young ‘uns can.
They need an income now.

If you build it, they will come

And so, not for the first time, the British instinct is to look to property.
Already 65-74 year olds are most likely to own a home, according to the Office for National Statistics.
That might not seem surprising, but just 20 years ago it was 35-44 year olds who made up the greatest part of the UK’s landed gentry.
Without rehashing the affordability arguments – a quick search on Google will churn them out by the dozen – it’s well known that younger people are finding it hard to get onto the property ladder.
And that means an opportunity for pensioners with the readies on hand to load up on property.

If you’re not part of the solution…

Now if you think this increasing concentration of wealth in a shrinking and ageing cohort is a dangerous trend that might have unpredictable social consequences – I’d agree.
But equally, it’s a bit much to expect an income-seeking pensioner to voluntarily step aside from the fray.
Hate the game, not the player, as the dealers in The Wire used to say.
All the same… I have an alternative.
Rather than owning a buy-to-let property – with all the hassles of exploding boilers, surly tenants, and endless bills for repainting and repairing – I want to highlight an alternative way to get an income from the property sector.
One that could help fix the property shortfall problem, and so make those grandkids love you rather than shake a rake at you in a peasants’ uprising.
My suggestion is to invest in the shares of the housebuilders.
These companies are also looking to profit from the property imbalance.
Not by buying up more of the scanty supply of housing stock, however, but rather by adding more homes to the nation’s inventory.
And they’re doing rather well.

Will 7% do for you?

You see, the builders have recovered from the downturn of a few years ago.
Today they are profiting mightily from the seemingly insatiable demand for more property, especially in the crowded South East.
So much so that even as they add to their land banks and see construction costs creep up, they still have more leftover loot than they can sensibly use.

And so rather than repeat the traditional boom-and-bust dance of not using that cash sensibly, some are singing a new tune – promising to pay out their excess cash to shareholders as what I consider to be very generous dividends.
Berkeley Group (LSE: BKG), for example, is expected to pay out around 7% a year for the foreseeable future, and mass-market player Persimmon (LSE: PSN) isn’t far behind, with a predicted 6.5% yield.
These payouts dwarf the yields on most unlevered buy-to-let properties these days, let alone cash, and with none of the hassle of finding your tenants’ kitchen sink is blocked up with mouldy pot noodles and coffee grounds.

When the cheque isn’t in the post

Of course, one reason these dividends yields are so high is because the market isn’t convinced they’re safe.
If the payouts looked nailed-on, then share prices would be bid up and the dividend yield would come down.
What’s the market’s problem, when builders in the South East can’t seem to build homes fast enough?
Well, leaving aside short-term worries like the General Election, the main fear is surely that prices aren’t sustainable – either because interest rates will rise or buyers evaporate – and therefore that house prices will inevitably crash.
And that brings us full circle.
You might argue that a pensioner who owns a buy-to-let property will suffer in a house price crash, too.
However, it might not matter too much if they’re buying with cash and so they don’t have negative equity or mortgage worries hanging over their head – just so long as the rent keeps coming in.
In contrast, the market capitalisation of Barratt Developments (LSE:BDEV) fell over 95% during the last financial crisis.
Even worse, its dividend was scrapped, and was only reinstated a couple of years ago.
Not a pretty prospect if you were a pensioner relying on Barratt for your spending money.

Mind the inheritance

For that reason, tempting though these yields are, I’d only ever suggest a share-heavy approach to retirement to relatively wealthy pensioners who have their basic needs covered by safer investments.
And I’d stress the need to diversify, too, across dozens of shares and probably also funds and investment trusts, too.
Having a couple of builders in a well-spread portfolio looks like an acceptable risk to me, given those rewarding dividends on offer.

But entirely relying on the volatile UK housing market to fund your golden years?

Maybe not!

We're in it for the long term here at the Motley Fool, and we focus on investing in businesses for years rather than months. It's over that kind of time horizon that we can make sensible judgments on how a business is likely to perform, and whether the price is right.

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Owain owns shares in The Berkeley Group.