april 2021
it’s the tax year end… DO I USE my SAVINGs FOR PENSION CONTRIBUTIONS?
OR INVEST in PROPERty?
I recently read Hargreaves Lansdown’s very neat & informative fact sheet on the pros & cons of investing in a pension vs. property. Whilst useful, it is in my view aimed, understandably so, at the mass market retail investor and doesn’t address :
those who are higher rate earners with a diminishing personal pension allowance
those who are experienced property investors themselves or invest with experienced investors, so are better equipped to both add value and maximise rental returns on property investments
As April 4th comes around, for many PAYE employees - including myself and my partner, these weeks traditionally include the hotly anticipated annual pension contribution debate... !! You can tell March is a fun time in my house.
IN SUMMARY:
For as long as the 40% tax relief is available on pension contributions, I see this as an easy decision and my first priority
After this point, the argument for me becomes less compelling and I tend to favour allocating to my property portfolio rather than locking the funds away for 25 years
Most of the property concerns HL raise can be factored in upfront through preparation and due diligence
The key factor to consider is the time it takes to build & manage a property portfolio. For those with the capital but not the time, partnering and investing alongside experienced property investors is a great way to maximise the benefits whilst protecting your own time.
Click here for further reading: Hargreaves Lansdown fact-sheet
AT LENGTH:
Time and brain space are spent weighing up the guaranteed 40% or 20% tax relief against the feeling of loss, not seeing hide nor hair of that hard-earned cash for 25 years at least. For me this decision is compounded by also being a private property investor, deciding whether to trust the financial markets and a fund manager I will never meet or myself and my property investment beliefs & process.
HL identify their 6 key areas of consideration in the debate. Below are those same key headlines, including an important overlay I believe is required to fully consider the argument from the perspective of a high earner and/or experienced property investor.
1. Returns
For those to whom the 40% tax relief on pension contributions is available, this is unparalleled considering it is guaranteed & immediate, and in my view should be maximised whilst the relief is still available. Like all tax rules, this 40% relief may change in the future, especially as the Treasury tightens the purse-strings to recover from the last 12 months of pandemic-level spending.
When it comes to general market return comparisons, HL compares average financial market growth against gross property market growth & income data. I feel this neglects:
The pivotal fact that unlike financial markets (where margin & leverage is reserved mainly for ultra-high-net-worth investors), property investment benefits much more widely from leverage. As a high earner able to obtain a standard 75% LTV Buy-to-let mortgage, this means growth returns are quadrupled - you get the market growth of 100% of the asset value whilst only having invested 25% of that value.
As a property investor, I would only buy property where there is the ability to add further value (+15%) within the first year. This gives equity levels a kick-start or alternatively would enable a large portion of the initial 25% deposit to be re-couped when next re-mortgaging, and still keeping ownership of the asset long-term.
When it comes to rental returns, the cost of leverage needs to be factored in first, however experienced investors will only invest where there is evidence of strong tenant demand at the right price. Personally, we look for properties that will result in a minimum of 15% annual return on our capital invested (ROCE).
2. Tax
There is no doubt that Pensions are highly tax efficient, particularly in the growth phase, with a secondary benefit of a 25% tax-free lump sum available at retirement.
The fact sheet assumes that property purchases are done in personal name, therefore citing CGT & Income tax as concerns; however limited companies are increasingly being used to professionalise the property investment industry. A corporate structure allows portfolios to be run as businesses, only paying tax on profits, and thereby allowing pre-tax investment into additional assets rather than waiting and saving up post-tax personal income for your next investment.
I agree with HL with regards to stamp duty - it is a big consideration for many when buying property. The last 9 months have proven this, with what is a maximum of a £15,000 saving causing buyers to drive up property prices by 7.3%, thereby reducing the benefit of that same saving. Experienced investors factor this cost into any appraisal, ensuring the investment returns still stack irrespective.
3. Getting Cash at Retirement
I would rename this ‘Accessing Invested Funds’, highlighting my biggest reservation when allocating funds to my pension - the fact that it is locked away and I can’t benefit until retirement.
Property however allows you to start benefitting from rental income immediately and potentially receive lump sums after a few years when re-mortgaging to release growth or added value. At this point, you can draw on this growth as salary/dividends/income, or time the equity release to re-invest in additional purchases pre-tax.
I personally disagree with HL on their points regarding control:
When investing in an actively managed pension I am at the whim of fund managers. Yes, I can change fund manager to a different person I have no control over, but ultimately I would need to become a financial markets expert in order to take full control and self-manage my pension.
In contrast when I invest in property:
a) I get to pick my tenants, or pick the managing agent who picks & manages those tenant – they are answerable to me directly, unlike a fund manager
b) I have control to invest in particular locations or in improvements to certain properties to increase their value
c) I get to pick & pivot between strategies, renting as a single let, multi-let or serviced holiday home depending on market conditions
d) I get to control and have visibility over the property & management costs
4. Risk
HL’s point on over-exposure, diversification & risk applies to all markets. All markets rise and fall - I personally don’t believe anyone can predict their movements consistently, we can simply read the signs and respond as best we can. For me, the property market is fundamentally supported by the fact that the UK has not met house building targets consistently for the last decade, and the pandemic has put further setbacks on these plans.
Housing is a basic need for all in our society, therefore either the government needs to support and incentivise developers to build more homes, or demand will continue to outstrip supply and market growth will remain underpinned. Experienced property investors can be poised to benefit from either outcome.
5. Cost
HL chose to avoid the debate on active vs passive fund management for pensions and the often great disparity in cost. This is something I continue to weigh up myself. Regarding the cost of running rental properties, this is an important point – maintenance, rental voids & managing agent costs should always be factored into the projected property returns and considered before putting in an offer.
6. Practicalities
Other than the initial upfront decision making or general monitoring, the day to day running of pension investments in purely passive. This is very different to property where sourcing, conveyancing, tenant management and any refurbishment or maintenance work can create serious stress and drain on your time. Letting & management agents can remove some of this pain, however, this isn’t a silver bullet. For those who want a fully passive property investment (without employing someone directly), the best option is a joint venture partnership. Working with a team of experienced investors and developers who give their time & expertise, just as you give your investment funds, with each getting a share of the profits. Most importantly this gives stress-free rental income & exposure to the property market without giving up your precious spare time.
Vanessa Mitchell - Director @RegentsView
Click here for further reading: Hargreaves Lansdown fact-sheet, BBC Housing Supply Article & Independent Housing Supply Article.
Disclaimer: The above represents my personal views only and is not reviewed or endorsed by my employer. This is also not personal advice or a recommendation to buy, sell or hold any investment. If you’re not sure about the suitability of an investment for your circumstances, you should seek advice. Pension and tax rules can change, and any benefits will depend on your circumstances.