Property Investing vs. Pensions, ISA and other Alternatives

“I want to get into property” … is a common sentiment uttered by many. However, when I question why they want to invest into property, I am usually met with a blank stare. This baffles me.

Despite what you might read or hear from others, property investment is a capital intensive game. Even the cheapest property which makes sense as a long-term investment vehicle will be in the multiple of tens of thousands of pounds. You are most likely going to be using leverage to some extent, which brings its own risks and complications. It is also more akin to running a small business, given that you have clients (in the form of tenants) to attract, convert and retain.

You should be absolutely sure that property investing is right for YOU. Again, despite what others might say, I don’t believe property is for everyone. You will need some combination of money, knowledge and time to be a property investor along with a capacity to appreciate, mitigate and manage risks. So before you even think of purchasing your first property, you should ensure the extra effort makes sense instead of investing your capital in alternative investment vehicles.

Naturally, I am biased towards property. But that is because I believe it is a good fit for me. Is it a good fit for you? This article aims to compare property investment with other investment vehicles, considering both the (in my opinion, considerable) advantages but also the disadvantages, to allow you to make up your own mind.

Alternative Investment Classes

As the saying goes, you can only spend (or invest) each penny once. There are alternative means for investing your capital which I will consider here and compare with property investment.

Essentially, there are three main ways you can allocate investment capital instead of (or alongside of) property:

1. Pensions (with the capital then invested within the pension wrapper).
2. ISA (with the capital then invested within the ISA wrapper).
3. Alternative vehicles: Fine wine, classic cars, art etc.

Let’s consider each in turn.

Pension Investment

Firstly, if you have a company pension scheme which allows for matched contributions from an employer, then you should absolutely take advantage of this. It’s free money, which doesn’t happen often in life!

This section deals with the question of investing extra funds into a pension, whether corporate or private.

A quick aside: There are types of private pensions, known as SSAS (Small Self Administered Scheme, an occupational pension usually established by Directors of limited companies) and SIPP (Self Invested Personal Pension, a self-administered pension that allows individuals to make their own investment decisions), both of which allow investment into commercial property investments. So there is some overlap with property investing here, but residential or mixed-use properties are excluded (or more accurately, attract huge tax disadvantages) so it is not for the beginner and any income remains in the pension.

Note that a pension is really just a tax wrapper with associated conditions. Once the capital is inside the pension itself, then you have extra decisions about how that capital is allocated into actual investments. Usually, these are in the form of differing fund options with differing risk profiles and exposures to different markets, investing (usually) in equities (shares in individual companies) and bonds (IOU’s issued by companies to raise funds for investment).

How you should allocate capital within a pension is a whole other ball game and there are tons of books written on the subject of investing in funds, trackers, equities and bonds.

I am just going to address whether you should allocate investment into a pension rather than a property in the first place.

Tax Relief

One of the biggest benefits of investing into a pension is the tax relief on the way in. At the time of writing, you will get tax relief on pension contributions of up to 100% of your salary, up to the maximum annual allowance of £40,000.

Any contributions made over and above this allowance will be added to your income and taxed at your nominal rate.

There are some exceptions to this, but this is the essence of the tax advantage of investing into a pension.

There is also a cap on how much you can build up in your pension. At the time of writing, this is currently £1,030,000.

This is particularly attractive if you are a higher-rate tax payer, as you will receive a higher rate of tax relief on the way in.

Your Options at Retirement

If you have a defined contribution pension scheme, then from April 2015 you have been able to take as much money out of your pension as you want. However, only the first 25% is tax free. Any money over this amount will be taxed as income.

If you are investing in a pension, then by definition you are investing for retirement. This means generating an income sufficient to live on into your old age.

With this in mind, then aside from taking a lump sum, you can do the following.

Guaranteed Income for Life

With the remaining funds, you can purchase an annuity. Effectively, you swap the remaining cash for a guaranteed income for life. How much income you get will depend on the annuity provider, your age, your health, whether you want it indexed linked to rise in line with inflation, whether you want the benefit to pass to your spouse when you die and so on. Here is an example annuity rates chart.

Flexible Retirement Income

Alternatively, you can keep the remaining funds invested with a view to those funds providing you with a regular (taxable) income. Note this is not a guaranteed income like you will get with an annuity, so you need to manage your remaining funds carefully.

Take Small Cash Sums

A third option is to take regular cash lump sums as and when you need them. Normally, the first 25% of a cash withdrawal is tax-free. Depending on your pension provider, there may be charges for each cash withdrawal and a limit on how many you can take each year.

Comparing Pension Investment with Property

So, how does investing funds into a pension scheme compare with property investing?

Advantages

Tax Relief

Clearly, this is an advantage. As a higher rate tax payer, every £1.00 invested into a pension is only going to cost you £0.60. This is the equivalent of getting 40% leverage, with the advantage that you don’t have any interest payments and you don’t have to repay the loan!

This gives you the opportunity to invest and compound the “free” money into an even larger pot.

Forced Savings

Pension contributions into a corporate scheme are usually taken straight from your pay packet before you get the rest paid into your bank account.

For those of you that struggle with the discipline of saving, or suffer from procrastination or an ability to take action such that you will never get around to making alternative investment provisions such as property investment, then this is actually a compelling reason to put money into a pension. It will happen month-in, month-out without you having to make any extra effort. A form of automated saving, if you like.

Ability to Guarantee Income

There are arguments for and against buying an annuity at retirement, but if you are the type of person that values the certainty, then an annuity is a good choice. Granted, it won’t be the best return on your capital, but having that certainty might be worth it if an annuity will meet your income needs. You can get the annuity to be inflation-linked too, albeit at a reduced income.

Annuity rates are not at a level to create excitement though. At the time of writing they vary between about 3.5 – 4.5% depending on what you require. This means a typical payout of £4,000 per annum on a £100,000 investment pot. It is not hard to beat this with property.

Disadvantages

Limited Leverage

Apart from the tax relief on the way in (which is a big bonus), you cannot leverage your funds the same as with property investment. At the time of writing, buy-to-let mortgages are plentiful at 75% LTV (loan to value – so you only need to provide the 25% deposit) and exist up to 85% LTV with certain lenders and products. There are limits to this as the rent must support the mortgage payment to an acceptable stress test by the lender, but in principle you can borrow a considerable portion of the investment. This can turbo-charge your returns on capital investment, but come with associated risks.

Cannot Force Appreciation

One of the biggest negatives for me. With a pension, whilst you have control over what investments your capital is allocated to, after that decision has been made you are at the mercy of the companies and markets you have chosen. You have no practical way to influence the performance of those investments and essentially have placed your faith in the boards of the companies to provide a return!

There are many ways you can force appreciation in property to provide either an instant uplift in value or in income, or both. As an example:

• Creating value uplift via refurbishment, extending or developing.
• Creating income uplift via intensification of use (e.g. renting by the room).

No Income Before Retirement

You have to wait until you are at least 55 to have access to your pension pot. Before then, you cannot create any income from it. A property can generate income from day 1 of being let. This adds flexibility to your current lifestyle, not a future one.

Lack of Control Before Retirement

A pension makes no provision for a change in your direction, aims or lifestyle before retirement age. Want to use that capital to invest in a new business? Nope. Want to generate an income so you can drop to working part-time? No again.

Those funds are locked, unable to be accessed, until you reach age 55 at a minimum. Property gives you much more flexibility as you can take income immediately or sell and pocket the equity gains (post tax) for deployment elsewhere.

Changing Legislation

To be fair, this affects property investors too. However, as a property investor I can make immediate choices from the result of new legislation. I have the ability to adapt my business model or, if I wish, exit the market altogether.

If the government of the day decides to change pension rules, then I am stuck with it.

Need to Understand Fund Choices

Fundamentally your pension is invested in the markets. Usually, you need to make the choices of which funds to invest into. This might change over the course of your life, as you may be willing to take more risk the longer you have until retirement age.

This means having an understanding of what each fund does, it’s risk profile, investment aims, charges and an understanding of the macro-economic environment under which that fund operates. This might be right up your street, or it might fill you with  combination of dread and boredom (if you are like me).

Pension Summary

Pensions can be an excellent way to save for retirement. If you have a defined benefit scheme or an employer matched contributions, then it would be sensible to take advantage.

The bigger question is around defined contribution schemes or allocating capital over and above the amounts required to be matched by your employer. Or taking out a private pension if a freelance consultant (which is the position I was in).

If you like:

• Not to have to think too much about it
• Like the idea of certainty via an annuity at retirement
• Think you lack the discipline to do anything else

Then a pension might be your best choice. However, if you want:

• Full control over how, where and when you invest or exit
• The ability to take an income now
• The ability to increase the income or value via forced appreciation

Then property investment might be for you.

ISA Investment

An ISA, or Individual Savings Account, is another type of tax-free wrapper for your savings and investments. You can invest primarily in:

• Cash savings accounts
• Equities
• Investment funds
• Bonds
• Peer-to-Peer Loans
• Crowdfunding Debentures

For the purposes of this comparison, I am going to ignore Lifetime ISA’s as you need to be under 50 years old and are only allowed a max of £4k per tax year as investment, which isn’t really a viable alternative investment vehicle to the amount you need to invest in property.

You can only invest a maximum of £20,000.00 each tax year into ISA’s.

The advantage is that, within the ISA, you don’t pay tax on:

1. Cash interest.
2. Income or capital gains.

Note that it is, of course, possible to invest in any of the above outside of an ISA, where there is no restriction on the amount of capital you allocate. However, for the purpose of comparison with property investing, I have chosen the most tax advantageous route you could go down, which is to use an ISA wrapper. The sums involved are comparable with those you would need to allocate to property investing.

Advantages

No Tax on Income or Capital Gains

The biggest advantage of investing in an ISA wrapper is that you pay no tax on the income or capital gains arising from your investment.

If you were to compare this with property, you pay income tax on your net profits from rentals and as from 2020 onwards, will only receive 20% tax relief on any mortgage interest payments (unless investing via a Limited Company).

Similarly, property investment disposals attract Capital Gains Tax of 18% or 28% depending on your personal circumstances, although you will benefit from using your annual CGT allowance and lettings relief.

Liquidity

Decide you want all your cash back out, like, today? No problem. The advantage with (most) ISA investments is that they are extremely liquid. You could sell your entire holding today and revert to having the cash back in your bank account. This is great flexibility for emergencies.

In contrast, property is not liquid. It takes a while to find a seller and potentially months for that sale to complete. In a market downturn, sellers will be thin on the ground.

The golden rule: Don’t invest money in property that you are likely to want back in a hurry!

Disadvantages

No Leverage

Whilst using leverage brings risk into the investing dynamic, this is a huge advantage for magnifying your returns on capital invested. Any ISA investment cannot be leveraged – try going to your local bank manager and asking for a loan to invest in the stock market!

This is a considerable disadvantage, as even very low leverage levels magnify your returns.

Let me illustrate by way of an example. Assume you buy a property for £100,000. It rents for £600 per month. After 1 year of ownership, it is worth £110,000. I am going to ignore buying costs such as legals and stamp duty for the purposes of this example or the potential for forced appreciation, in order to keep it simple. Similarly, I am going to ignore voids and maintenance for the same reasons.

Example 1: Unleveraged

You pay £100,000 in cash for the property. You achieve a rental return of (12 x £600) / £100,000 = 7.2% on your capital.

After 12 months, you have also returned a capital or equity gain of £10,000 / £100,000 = 10% on your capital.

Pretty good right? A total return of 17.2% in income and growth.

Example 2: Leveraged

This time, let’s assume you take out a mortgage for 60% of the property purchase price, which is £60,0000. Let’s take a mortgage interest rate of 4%, so your annual interest-only mortgage costs are £60,000 x 0.04 = £2,400. Now you only need £40,000 cash from your capital pot to complete the purchase at £100,000.

Now you receive a rental return of ((12 x £600) – £2,400) / £40,000 = 12% return on your capital.

After 12 months, you have also returned a capital or equity gain of £10,000 / £40,000 = 25% on your capital.

Your total return has now increased to 37% in income and growth, more than double the unleveraged example. What’s more, you still have £60,000 of capital to invest, so could potentially do another identical investment and still have £20,000 left over.

Of course, leverage works both ways and comes with associated risks (e.g. mortgage interest rate rises) and tax considerations, but this simple example shows how powerful it can be and we haven’t even touched on ideas such as:

1. Buying well. What if you could purchase the property for £90,0000?
2. Forced appreciation: What if you could undertake a refurbishment for £10,000 that mean the property would then be worth £120,000?

I will cover this in later articles, but hopefully this shows the potential for returns and expansion using the power of leverage.

Market Intelligence

How good are you at:

• Understanding fund performance, fees and charges.
• Understanding the fundamentals of a company, reading company reports and choosing companies to invest in.
• Understanding the macro economic and global environment under which you are investing.

This is not easy. Most investors think they are better at this than average, when the vast majority are not. If this excites you, motivates you and you think you have an edge, then go for it. But most don’t. Granted, you can invest in tracker funds, but your returns will be lower as a result.

Cannot Force Appreciation

Similarly with pensions. You choose a company or fund to invest in and sit back and wait. Basically, you have transferred the responsibility for performance from yourself to either the fund manager or the board of the company. You have no control over how well they might do.

With property, you have direct control and direct choice. You have (or can learn) the ability to spot investments where you can increase the value, the income or both, which is much simpler than spotting companies that will outperform, simply because you are in direct control with the property.

However, this requires a combination of money, knowledge and time.

Value to Zero

If you invest in individual shares, either for income via dividends or for capital gains via an increased share price, then there is always potential for both of these to go to zero. A company can elect to stop paying dividends indefinitely in times of trouble. Similarly, a company can go bust or into liquidation, rendering itself worthless. Note that equity investors are at the bottom of the pile in such circumstances, any remaining money in the company will be used to pay off bond holders first.

With property, both of these scenarios are extremely unlikely. Granted, a tenant can stop paying rent, but there is a robust legal system to evict such tenants, so the loss of rent will only be temporary, not indefinitely.

A property’s value will also not go to zero. It might reduce in times of market downturn, but will always have some value, predominantly because we are not making land anymore!

ISA Investing Summary

ISA investments are great if you having the enthusiasm and skill for choosing wise investments. If you are a skilled trader, you can grow your investment pot rapidly, tax-free. But I would wager the vast majority of people (including me) are not good at this, or simply don’t have the motivation for it.

If you take the sensible route of investing in index trackers as you recognise your lack of ability to outwit the market, then your returns will be subdued as a result and you will not have the advantage of leveraging your investment as with a property.

Alternative Investments

In this section, I am considering all other types of investment away from the capital markets. This includes:

• Fine wine
• Art / antiques / collectables
• Classic cars

And so on. I would wager that this type of investment only makes sense if you are passionate about the subject and have a deep knowledge. These are certainly not investments for the beginner and in some cases will require large capital sums.

They all suffer from the following to some degree:

• Inability to leverage.
• Doesn’t produce an income (granted, there might be some opportunity in renting out classic cars for weddings and so on).
• Capital growth partly dictated by trends (certain art and cars go in and out of fashion).
• Storage issues (wine will need careful storage, as will a classic car for example).

You do have some advantages, principally that you can derive personal enjoyment from your purchases. For example, you can hang art in your home or drive a classic car. However, this is a corollary of ownership and not a reason for a good investment in the first place.

Indeed, even in property, if personal use is important then you have options. You could, for example, buy a property suitable for holiday lets or serviced accommodation. This provides scope for personal use should you wish, whilst still generating income when you are not using it.

Conclusion

The point of this article is not to say property trumps all other types of investment. It can be prudent to still have a pension, ISA and other investments.

It is up to you to decide if property should form part of your investment plans for your capital. I have tried to outline the arguments above and whether property is right for you really depends on your attitude to risk, business acumen and income and growth goals.

You will also need a mix of money, knowledge and time to become a property investor. This mix, along with your objectives, attitude to risk and capability to run a business, will determine what type of property investment you undertake, if at all.

As I said in the beginning, property isn’t for anyone. But what it does offer is:

• Control: You choose when you take income or capital (in the event of remortgaging or selling).
• Ability to force appreciation: You can buy well in the first place and / or add value via refurbishment, extensions, planning gain or development.
• Leverage: Even at conservative levels of investment, this can turbo charge your returns on capital employed.
• Inflation hedge: The act of inflation erodes your mortgage debt, meaning long term buy-and-hold strategies generate wealth over a sufficiently long period.
• Blended return of income and growth: You can focus on income, capital growth, or a mix, depending on your investment objectives.

Hopefully this have given you an insight into the relative pro’s and con’s of property investing alongside with other investment vehicles for your capital.

If this has whet your appetite, then you should consider my top 7 reasons for investing in property as your next step.

What about you? Are you considering property investing, or perhaps have made a start? Let me know what you think in the comments below. If you have any questions on the above, either ask below or reach out to me and I will endeavour to answer.