Monday, 18 May 2015 00:00

Profits and pitfalls of the pension pot buy-to-let

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Auction stations: over-55s could soon be joining the bidding at property sales. Auction stations: over-55s could soon be joining the bidding at property sales. Image: Getty

When your pension lump sum burns a hole in your pocket, be aware that London rental yields are at their lowest for seven years. So buy-to-let may not equal get rich quick.

Britain is poised for a "silver wave" of buy-to-let landlords, with thousands of savers expected to take advantage of new pension freedoms to invest in bricks and mortar.
From the start of the new tax year on Monday next week, over-55s will be able to cash in their pension plans to invest or spend the lump sum as they like, rather than swap these funds for a traditional annuity income.
Some reports suggest property auctions and the buy-to-let market, usually dominated by younger investors, could be flooded with as many as 500,000 savers keen to use their pension cash to invest in rental properties - though Tom McPhail, head of pensions research at investment advisers Hargreaves Lansdown, says a more realistic estimate may be in the low tens of thousands.

Buy-to-let has certainly been lucrative for many people. Landlords made 16.3 per cent a year on average from mortgaged buy-to-let properties between 1996 - when buy-to-let mortgages first became available - and the end of 2013, according to a study for Paragon Mortgages.
This return includes rental income and capital growth as well as allowing for mortgage and maintenance costs, and is equivalent to turning each £1,000 invested into more than £13,000 over the 17-year period.
By comparison, returns on unmortgaged buy-to-let properties were 9.7 per cent a year on average, while the stock market averaged just 6.8 per cent annually, with four per cent from cash.
Rob Thomas, the housing expert who calculated the returns for Paragon, adds that buy-to-let properties in London would have done better still, with £1,000 invested into a mortgaged property in the capital growing to more than £20,000.
Savills, meanwhile, calculates that landlords made a staggering £177 billion in capital gains alone over the past five years as property prices recovered after the financial crisis.
After such strong returns, however, prospective landlords should not assume buy-to-let will be as profitable in the coming years.
London’s high property prices mean that rental yields - the annual rent as a percentage of a property’s value - have come down to just 4.3 per cent on average, their lowest since 2008, according to data from LSL Property Services. And this figure is before tax and costs, such as maintenance and mortgage interest. “In London it can be hard to generate income [after costs] at all,” says Thomas.
Across the country, the typical rental yield has slipped to five per cent, says LSL, although landlords can find higher returns in some regions - in the North-West the average yield is 6.8 per cent - and with certain property types, including ex-council and shared properties known as HMOs, or houses in multiple occupation.
Meanwhile, with the recent cooling in property prices, a range of forecasts suggest capital values will rise by less than five per cent this year.
Savills also predicts that price growth will be generally subdued for the next five years, with London prices rising by as little as 10 per cent between now and 2019, and most regions up only by about 20 per cent.
However, even with more moderate returns in prospect, buy-to-let may still appeal to many savers compared to the low annuity rates on offer for their pension cash.
To buy a rental property outright with pension cash, savers will need to have a sizeable fund. Most people have less than £100,000 in total in personal pensions and the newer workplace pensions  - “defined contribution” or “money purchase” schemes - that can be encashed.
While it will be possible to transfer “final salary” - also known as “defined benefit” - pensions into arrangements that can be encashed, many financial experts warn that savers are likely to be better off keeping these traditional workplace schemes.
Savers cashing in pensions may also have to stomach a big tax bill. While 25 per cent of the value of most plans is tax-free, the rest will be taxed like other income when it is withdrawn.
By cashing in a pension policy worth £100,000, you’re likely to suffer tax of at least £20,000 and, depending on your other income, you may have to pay the top tax rate of 45 per cent on some of this money.
The good news for those wanting or needing a mortgage to buy a rental property is that loan rates are at historic lows. Average buy-to-let rates are under four per cent, according to researchers Moneyfacts, with two-year fixed rates and trackers available at less than three per cent.
And, unlike with a mortgage on your own home, there is tax relief for loan interest on a buy-to-let property. Offsetting mortgage interest against rental income saves many landlords more than £1,000 in tax each financial year.

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