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planning for retirement: pensions vs buy to let part 2

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Lincoln “the steep hill”Yesterday, after a comment on ISAs versus pensions from Nick, I described one way of using a buy to let investment to fund a retirement. Today, I’m comparing that to a standard pension invested in the stock market.


Yesterday I calculated that 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.

what about a pension?

If instead, the £30,000 lump sum and the £228 monthly contribution was invested via a pension, returning an average 7% per annum with fees of 0.5% annually, this would result in a pension fund of approximately £514,000 (found using this pension calculator). Which using the same 4% figure as before, would give a retirement income of £20,560, approx £8,470 in today’s money.

comparing buy to let and pension

Clearly, £9,390 is bigger than £8,470 so there is a reasonable potential for a buy to let investment to provide you a bigger retirement income than a pension invested in the stock market.

I would also note, that neither of these have provided what I would describe as a really generous retirement income. It looks like £30,000 plus £228 a month for 30 years won’t go as far as you might think in your old age, so the more you can invest sensibly the better you will do.

is the buy to let a better choice then?

Well, it’s a riskier choice, and greater risk means that there is the potential for greater reward. In my analysis yesterday, I made the following five main assumptions:

  1. the property is occupied 90% of the time
  2. maintenance costs are 10% of the rent
  3. the yield on the property is 5%
  4. the interest only mortgage is at 6%
  5. the value of the property grows at 2% above inflation

In contrast, the main assumption (and so risk) in the pension calculation was that the capital growth would be 7% per annum.

Of the property risks, the interest rate on the mortgage is most significant early on, (later on, inflation can eat away at the cost) since it’s an interest only mortgage a 1% change in the mortgage rate (to 7%), would lead to a more than 16% increase in the monthly mortgage repayments. That’s a lot of money.

The other factors depend a great deal on your ability to pick a good property. A single buy to let investment is not very well diversified. If it has the neighbours from hell, then you’ll get a lot of tenant turnover. If the rental market becomes flooded with properties then your yield will be lower. If you bought an overpriced house, it’s capital growth will be lower.

In to the risks inherent in owning property, there is some hassle factor associated with being a landlord, even if you use a management company. This isn’t a totally passive investment - although it can come pretty close.

i’ve thought of a better way of using buy to let to fund my retirement

Excellent. Tell us about it in the comment section. I’ve only looked at one way of using buy to let as part of a retirement plan. And I didn’t pick it because I thought it was necessarily the best, I picked it because it was easier to calculate.

I discussed this with one of my friends who has a small (3-5) investment property portfolio, and he suggested that you could re-mortgage properties as their value increases and then use the released funds to invest in more properties or in the stock market. I don’t know if that’s a good idea, it’s just another one I’ve heard.

plonkee’s thoughts

I haven’t got a buy to let investment. I’m not planning on having a buy to let investment. The barrier to entry is too high - I think that it would take me at least 10 years to create enough capital to be in a position to invest even if I wanted to. I’m also too lazy. I can rebalance my investment portfolio with the touch of a button. You actually have to do work when you’re a landlord.

I think there’s quite a lot more risk in buy to let than I’m willing to take on. I don’t have the stomach for cash-flowing an empty property. I’d probably lie awake at night worrying about how I’d pay two (or more) mortgages on one salary, and that is not worth it to me.

Image by jlcwalker.

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8 comments for “planning for retirement: pensions vs buy to let part 2”

  1. I don’t know that this is true, but in the discussion following pension or buy to let, Annie said she had a holiday let.
    Buy to Lets were taken out of Self Invested Pensions, but I half-heard that holiday lets (which met a letting criteria, not just be a second home) could still go into SIPs. Don’t think it would apply for Annie as you have to buy it in your SIP at the outset (she sounded like she already owned the house as a personal owner). Does anyone know about (do!) this?

    On my own part, I’d like a buy to let (outside a SIP), ideally a nice seaside cottage which I’d let for 10 years or so, and then get to live in for a while (and avoid capital gains tax to boot..!). Whilst I’m now comfortable(ish) with financial risk, though, I haven’t yet built my risk tolerance for human factors. (I don’t think tenants are evil scumbags- it’s just that it’s not in their interests to look after your place, even if they are responsible people. And of course, not everyone is responsible…)

    Posted by Pippin | January 9, 2008, 3:36 pm
  2. I’ve spoken to about 20 people so far who are depending almost exclusively upon their buy to let portfolio as a pension plan (some have more diverse savings too). Only 2 of them managed the properties themselves (and both of those people said they had less than 5 properties each so far). The rest all use management agencies, say that the 10% fee is well worth it, and recommended I did the same unless I was nuts.

    One of the guys I spoke to said he is able to release more cash every 3-5 years through refinancing than he would through selling the property! (Refinancing is tax-free, but selling incurs capital gains tax). He claims around 2% of his portfolio back a year in refinancing, and has a large enough portfolio to claim £1000 a week for life (I didn’t ask, but I’d guess he was in his early 50’s). He’ll never own the properties outright or sell them, but will instead pass them down to his kids, who will inherit an amazing early retirement system.

    I think buying to let rather than buying to flip on retirement in this way is a pretty good alternative, so long as you buy cheaply, have the time and cashflow to build a good portfolio, and don’t attempt to grow it too quickly.

    Posted by Nick | Put Things Off | January 9, 2008, 4:46 pm
  3. I think that relying on buy to let for all of your retirement income is quite risky. Unless you have a very diverse portfolio. With pensions/ISAs/unit trusts etc, you can move away from equities and into bonds to mitigate the risk as you get older, but it’s much harder to reduce the risk in buy to let.

    If yor’re refinancing every so often, you might want to take different tactics as you come up to retirement - most people tend to envisage living off the rents, rather than taking their chances with capital gains. But that’s not impossible to do, as long as you leave yourself enough time to maximise your capital gains tax allowance.

    Posted by plonkee | January 9, 2008, 6:16 pm
  4. It seems that as with all retirement questions it is risk management. I agree with Plonkee, in that I wouldn’t just have the let, but if your fund is capable is seems like it could be a healthy part.

    Excellent posts and thanks for doing all of the math!

    Posted by RacerX | January 9, 2008, 7:30 pm
  5. I’m always fascinated by the different British terminology for financial vehicles! Makes it slightly more difficult for us Americans to follow though…but it is a Englisher’s blog after all :)

    Posted by Money Blue Book | January 9, 2008, 9:34 pm

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