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planning for retirement: pensions vs buy to let part 1

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I recently compared pensions and ISAs as investment wrappers after being inspired by a reader’s comment. In response to that post, Nick said:

It’s been suggested to me that a good option is to buy property to let over the same period I would normally be pay into a pension plan, then use that to fund a retirement plan instead.

Buy to let investments have been very popular over the last few years, and certainly a really comprehensive asset allocation plan would probably include property. How could you incorporate them into a retirement plan, and how would this compare to investing in the stock market via a pension?

In theis first part, we’ll look at one way of using a buy to let investment to fund a retirement. Tomorrow, in the second part, we’ll compare the results here to a standard pension.

what is a buy to let?

A typical buy to let investment is a small residential property in high demand in the rental market. Three of the most popular segments to aim at are:

  • young professionals - typically 1 or 2 bed flats
  • housing benefit recipients - inexpensive 2 or 3 bed houses, often in ex-council estates
  • student housing - 3 to 6 bed houses, close to a University, preferably in a student ghetto

upfront costs

To buy a property, you need a deposit, money for fees and stamp duty, and a mortgage. For a buy to let investment, you usually need a deposit of at least 15% of the value of the property. In addition to the set-up costs, there are ongoing maintenance costs, tax to pay, and fees.

For the sake of argument, let’s assume that the we’ll be investing in a property selling for £175k - about the average price of a flat in the South East of England. On this property, the deposit required is £26,250, and a mortgage rate of 6% would give you interest only repayments of £750 per month (these are tax deductible).

Your other buying costs I’ve estimated as stamp duty at £1,750, and (putting a finger into the air) conveyancing and legal fees at approximately £2,000. So you need an upfront investment of £30,000.

ongoing costs and income

A typical rental yield is about 5%, which means that the property could be rented out at around £725 per month.

You need to budget that the property won’t be rented out all the time, a 10% void rate is probably appropriate. Then anticipate that around 10% of the rental income will be spent in maintenance, and another 10% on letting agents fees. This means that the average monthly income from the property would be £522, leaving you with a net deficit of £228 per month.

capital gains and cashing up

Since the 1970s, the rate of increase in house prices in the UK has averaged about 2% above inflation. We’ll assume that will continue over the 30 years between now and retirement and that inflation will average 3%.

This means that on retirement, the property would be worth about £756,000. We’ll estimate that the selling costs would be 5% of the value of the property, and we’ve still got the £150,000 mortgage to pay off. This leaves us with a profit of £543,200, which will be subject to capital gains tax of approximately £114,200 - assuming that exempt amounts increase with inflation. This leaves us with a net profit of £429,000.

The profit can then be used to fund a retirement income, with 4% being a reasonable assumption, so it would give a retirement income of £17,160 (approx £7,070 in today’s money).

what about the rest of the money?

What? What extra money? Yes, in the first draft of this post I made a basic schoolgirl error in the calculations. I assumed that the rent would stay constant for 30 years. What an idiot. On the bright side, I realised in time to correct my post.

If we assume that the rent increases by 5% each year (the same as house prices, keeping the yield the same), and that any profit made (including the £228 per month) is invested in the stock market with returns of 7% per annum, then after 30 years, there will be an extra £141,000 in investments. This can then be used to fund additional retirement income of £5,640 - which is about £2,320 in today’s money.


In summary, for an initial investment in a buy to let property of £30,000 and a further constant £228 per month invested in cash-flowing the property, or in the stockmarket could give a retirement income in today’s money of £9,390.

Please note that I’ve done all these calculations from scratch, so I may have made errors in my assumptions, chime in if you’ve got better suggestions. I’ve tried to make all them all as reasonable as I can, but it’s certainly not guaranteed that any investments will perform in the way described above.

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19 comments for “planning for retirement: pensions vs buy to let part 1”

  1. Wow! Thanks for writing about this so quickly. This looks set to be a great series.

    While buying a property to let and then cashing out when you want to retire is what many folks do, there’s another option too.

    My current thinking is as follows:
    1) Carefully source small properties (under £120k) at 80% of the market value
    2) Pay a 15% deposit and fund the rest with an interest only mortgage
    3) Spend a minimal amount on refurbishment
    4) Refinance the property immediately after completing (4-5 months later) with an 85% mortgage at the new value
    5) Take the cash that’s released and do the same again!

    This effectively gives you property for free, and only ties your cash up for 6 months each time.

    I got the idea from a chap called Andy Shaw, who uses this example: You buy a house for £100,000 with an 85% mortgage. You’ve put in £15,000 deposit plus legal costs of £1000 and refurb costs of £4000. So you’ve spent £20,000 acquiring property worth £100,000.

    You get the property re-valued at £130,000, with a new mortgage for 85% of that, which gives you a mortgage of £110,500. Once you’ve taken your investment of £20,000 and paid off the original £85,000 mortgage, you’ve actually made £5,500, and you no longer have any cash invested in the property.

    You’re then free to use the same £20,000 to buy another. The whole thing works on buying small property under the market value, and then never selling it - if you can do that, it seems like a good way of investing to me.

    Posted by Nick | Put Things Off | January 8, 2008, 1:39 pm
  2. I REALLY wish my key board had that funny little “L” or pound symbol.

    This is great work, sometimes the owner of a rental property only makes money when his property is sold. He simply tries to break even while owning and letting.

    Posted by rocketc | January 8, 2008, 3:38 pm
  3. I missed the post on pension vs ISAs (doh!), but the ‘alternatives to pensions’ is a topic close to my heart.

    Obviously, I’m not a fan of the pension straitjacket, but anyone whose thinking they can choose between a pension or property needs to think REAL close, particularly when they’re sold on a message from dime-a-dozen property pundits. Plonkee didn’t mention costs of maintaining or re-furbishing a property, but this particularly applies if you think you’re going to profit from a quick turnaround of property (love the term flip; wish it was used in the UK more).

    Of course there are still people making money on property, but they’re generally v. experienced, or have a lot of capital behind them (probably both). It’s not a game for novices.

    Still, as someone who has a big stake in property (as part of a diverse portfolio which does include some pension), the more people that can be suckered into that market, the better .. :P (actually no, impact on overall economic conditions has turned that message on its head these days)

    Posted by Pippin | January 8, 2008, 5:39 pm
  4. Really interesting. Makes me want to go back and look at this given the changes in real estate pricing here!

    Posted by RacerX | January 8, 2008, 6:12 pm

  5. @Pippin - I completely agree with you on the danger of trying to ‘flip’ property by buying, refurbing and selling it (why sell an asset that is likely appreciating faster than most savings accounts?). Buying well, holding onto your assets, and refinancing if necessary (which is tax free!) seems like a better long-term plan to me.

    Unfortunately, I’ve learnt the hard way that careful buy to let investing has better long-term potential than the more speculative buy to flip strategy glamourised on UK TV. (I’m only just switching tactics myself.)

    Look forward to seeing how buy to let compares to a more traditional pension, though.

    Posted by Nick | Put Things Off | January 8, 2008, 6:46 pm
  6. It is certainly possible to make money by buying cheap property and refurbishing it. But that’s more or less separate from whether you choose to then sell the property on, or rent it out.

    If you refurb and then remortgage at a higher rate and rent the place out, you’ve still got the investment situation I’ve described above. The only difference is that you’ve come about the initial money (£30k in my example) more creatively.

    Buy to flip works well when you buy cheaply. Which is actually pretty hard to do when everyone else is trying to do the same thing. Because you’ll have some not very savvy newbie paying over the odds, driving up the price of the houses that flippers want.

    Posted by plonkee | January 8, 2008, 7:56 pm
  7. Yes - your point about the initial money and flipping vs letting being a separate issue is well made.

    I made the mistake of investing too much emotion in the property at purchase time, and ended up in a mini bidding war with a first time buyer.

    Now I’m coming to sell, I’ve realised I paid too much in the beginning. I’ll still make money, but as a pension plan I suspect it would work out pretty rotten compared to the safer alternatives.

    I guess that’s one of the main reasons people opt for pension schemes/savings over property: the risk of getting it wrong is probably much lower.

    Posted by Nick | Put Things Off | January 8, 2008, 9:16 pm
  8. It’s certainly easier to be more sensible about funds. I mean, I like my investment portfolio, but I can’t imagine falling in love with it.

    Posted by plonkee | January 8, 2008, 9:54 pm
  9. Ha! I see what you mean. Perhaps I need to learn to stop looking at houses as property buying decisions (which invariably tie-in emotion) and start looking at them as investment decisions.

    Posted by Nick | Put Things Off | January 8, 2008, 11:29 pm
  10. Along with Pippin’s comment, I think it is a good idea if you can swing it for the long term, but in my experience owning a rental is like having a pet, particularly if that rental is a little older.

    The maintenance costs (particularly surprises, like unexpected plumbing disasters that can cost thousands to repair), updating costs over the long term, the time and effort spent to maintain and repair after old renters leave and before new ones move in, all add up to a lot of inconvenience for many.

    That being said, if you are willing to either hire out much of the work or view the maintenance and management as a part time job, investment-wise I would say its a good bet. Particularly if your loan amount, including principle+, is paid by the let fee.

    Thanks again for a great post!

    Posted by metroknow | January 9, 2008, 6:54 am
  11. I’d also point out that there are a couple of different ways to approach the rental aspect, depending on the amount of work you want to put in, and geographical location.

    I own a pretty cottage next door to where I currently live. Having rented out a property previously, only to have it comprehensively trashed by a defaulting tenant, I was unwilling to do the same again.

    What we now do it holiday letting. Obviously, there is a LOT more work needed (advertising, turnarounds, keeping everything perfect etc.) as well as more investment (furnishing, linens etc.), but the payback is *much greater*.

    In the right place (and really, only research can tell you that), a holiday let will garner almost three times the long-let rental income.

    There are a LOT of factors involved in this decision, and you do need to see it as an active business, not a passive investment, but it can be a good strategy…

    Posted by Annie | January 9, 2008, 11:44 am
  12. Hi Annie, I would like to add that I thnk it is very important to attract the right sort of tenants to maximise the rental income. For instance, most young professional couples will be looking for convenience and a clean rental property.  They will expect a high quality standard of interior decor, as well as a well-kept and well maintained exterior.  Think through what you’re prospective tenant market is likely to expect, depending upon the property and the local area.  Students will have lower expectations than professionals, families more space orientated different needs than single people.  Most landlords tend to choose neutral colours which are cheap and easy to obtain, such as magnolia.  This ensures that after a few years, when the property needs redecorating, the colour is easily re obtainable. Most ‘hint of something rather’ colours tend to be rebranded after a few years by paint manufacturers for obvious reasons. Never try to decorate a property based on your own tastes. Instead, keep the average needs of your target market in mind. Neutral and clean colours throughout the property likely to attract prospective tenants during the viewing process.  Freshly painted walls will impress prospective viewers and a more likely to help you achieve your higher desired buy to let income.

    Posted by Buy to Let Landord Tips.... | March 31, 2009, 2:09 pm

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