With all the excitement around the new pension freedom regime, due to come into force next month, we may find retirement planning coming round full circle in a grand sweep of dramatic irony.
There is little that annoys pensions experts more than the old adage from members of the now retired ‘golden generation’ that “my house was all the pension I needed!” This much-criticised, old-school view – that investing in property instead of buying a pension was the key to a sound retirement – might well come back into vogue.
The reason property investment was such a runaway success for many people now in their 60s and 70s is that it is one of the few legitimate ways of investing in a high-risk strategy. Better still, the inherent leverage can act to significantly multiply gains. It is not really less volatile than investing in the stock market, but it feels that way given how infrequently bricks and mortar get valued.
For those who had stashed all their savings into a pension, leaving nothing left over to buy their own home or a second home, from April many will have the option to free up enough cash for a deposit, 25 per cent of it tax-free. Would buy-to-let be a sensible retirement income replacement strategy?
Firstly, a quick recap on the merits of the mortgage. If a fund manager were to amplify their performance by leveraging 100 per cent of their investment three times in a relatively high risk market, you would call them a crazy hedge fund manager, give them 1 per cent of your money at best, close your eyes and pray. But of course, this is precisely what happens when most people buy a house.
Let’s imagine buying a £300,000 property, which is close to the national average (although well below the current London average of £514,000 according to the Office of National Statistics in September last year) on a 70 per cent mortgage at 2.5 per cent annual interest, which is a broad current market rate for a buy-to-let. Your £90,000 liberated from your pension pot is, effectively, more than three times leveraged.
Then assume, perhaps heroically, that property prices rise 6.7 per cent a year – the simple average annual price rise since 2000 according to the ONS. Under this scenario your £90,000 would have netted you a £228,000 capital gain over 10 years – a total return of 242 per cent or 9 per cent a year, and that includes interest costs and stamp duty. Beat that, equities!
To cap it all off, if the house is rented out at a 5 per cent yield, or £1,250 a month, that adds a further £15,000 a year in income (£10,800 a year if netting off interest costs). Actual rental yields vary massively, from a paltry 2.8 per cent in Kensington (where the average house costs £1.2m) to a hefty 8.7 per cent in Southampton, according to HSBC.
Add in the income, assuming the rent uplifts as the house price increases, and after 10 years you can add £233,000 to your gain: that’s a total return of 501 per cent or 17.5 per cent a year.