One of the most frequent questions that arises in passing conversation is comparisons between our asset class and others, in particular housing-based asset classes, such as direct investment into property assets, and holding buy-to-lets. These chats usually include the pros and cons, the yield projections, risk and reward of capital appreciation, and a plethora of other comparables. However, at the end of the chat, the question that is posed is usually straightforward: which one is better?
In this week's blog, we unpack how that's a question...that can never really be answered.
This probably isn't the answer people want; however, a binary answer cannot be provided due to the sheer number of variables that would need to be considered. Before running our comparative scenario, one of the core metrics that could swing the winner either way is capital appreciation, and this is where it becomes a projection based on whose projection you are looking at. The more bullish end of the spectrum, for instance, Savills project a 5‑year increase of 24.5% in house prices, however for purposes of our exercise we are looking at the mid-range projections of the OBR, who project 11.3% over 5 years, and to be extra generous on the side of direct investment into investment property, we are rounding that up to 12%. Two key factors to consider are that capital appreciation is both a benefit and a risk; we can only work with assumptions and analysis. However, the second factor is that we agree with much of it; there is a greater probability of house price growth than retracement over a multi-year time frame, if for no other reason than a combination of scarcity and demand.
Now, before we dive into the numbers, there are a vast number of variables we are removing from the process to focus on the yields and the capital, if someone were making a genuine comparison between the two, with direct property investment you would have to include tenant defaults and prolonged vacancies, maintenance and repair costs, interest rates hikes, regulatory risk and exit costs, all of these would affect your capital and returns negatively. On the flip side, with our asset class, you can make a fair comparison by examining liquidity risk, interest rate risks, regulatory risk, inflation, and default. The fact that those things are mitigated doesn't mean they don't exist as risks. You could also consider tax situations. Investment properties are subject to income tax on rent, capital gains tax on sales, and mortgage interest deduction. In contrast, platforms like ours offer an IFISA wrapper, providing an element of tax-free income. You would also need to consider exit flexibility and associated costs.
Arguably, both sectors carry risk; selling properties takes time and carries fees, our sector relies on a liquid secondary market and takes time, all asset classes associated with the property market are subject to the performance of the underlying market, so it's less about which is best in terms of fundamentals, it's down to preference.
So, let's ignore the fundamentals for a minute and run our scenario. Here is a comparison of a £200,000 investment over 5 years, either split across two buy-to-let (BTL) properties or invested entirely in a platform paying 7.5% annual compound interest. This analysis includes earnings, pros and cons, external factors, and realistic assumptions. As mentioned, we are working off the assumption of a 12% growth in house prices across that period. Our partner purchases two rental properties in the Northeast, each worth £150,000, using 75% buy-to-let mortgages, and contributes £75,000 in total equity per property (including buying costs). The remaining £50,000 of their capital is held in reserve for maintenance, fees, and contingencies. Each property generates £900 per month in rent, equivalent to £10,800/year gross. Net rental income (after 25% costs and 5% interest-only mortgage) would equal an annual net income per property: £2,475 & over 5 years (2 properties): £24,750. Now let's look at capital growth: the properties appreciate by 12% over 5 years, the value increases from £150,000 to £168,000. Equity gain (after repaying the mortgage) = £18,000 per property. Total equity gain (2 properties): £36,000. Total 5-year return (net income + equity gain): £60,750.
Now let's assume the £200,000 capital is placed into a diversified loan portfolio, earning 7.5% compound annual returns, with capital and interest reinvested. Over five years, the final value after compounding would be £287,126, with a total gross gain of £87,126. No capital appreciation is on offer here, but no leverage risk is undertaken by the investor, and the returns are predictable, assuming no defaults or platform failure.
So, hang on, I hear you ask, does that mean one is better than the other after all?
Well, no, it's not; what this little thought experiment hopefully represents is that one has earned its place alongside the other. It's very easy to construct any scenario to tell a story you want to tell, and to paraphrase a well-loved Adam Sandler SNL sketch, where a painfully honest Travel Agent states, "you’re still going to be you on vacation. If you are sad where you are, and then you get on a plane to Italy, the you in Italy will be the same sad you from before" And by that we mean, if you're heavily risk-averse to start with, no financial market product will make you any less so, and let's face it, some of the effort and management and perceived "stress" of investment property, to some, is the sheer joy of it, it's not possible or fair to compare the two.
However, what we can say is just like the Romano Tours SNL skit, we can be painfully honest about the positive metrics on offer with our asset class, and just let the market judge us positively from there.
Invest & Fund has returned over £300 million of capital and interest to lenders with zero losses, showing the rigour that governs our business.
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