On the face of it, a second property gives you the best of both worlds. A place to holiday in, the chance to cash in a hefty lump sum in the future, and a regular income if you choose to rent it out.
The holiday rental market is booming, transformed by the likes of Airbnb. In the UK, more than one in 10 people own a second property.
Having a buy-to-let or other property investments can be a successful strategy as part of your wider investment portfolio. But how does it stand up in its own right?
We’ve taken a look at some of the main points and how they compare against more traditional routes of investing, such as paying into a pension.
What makes a good rental yield?
Some experts put it at around 5-8%. What’s most important is that, at the very least, you’re able to cover your mortgage and any other costs. Hopefully with something extra on top.
As recently as 2018, the average rent on second homes was more than £1,000 (and even double that in high-demand areas like London), so rental income from a second home can look very appealing.
Ultimately, your income depends on the current state of the market, which can go down as well as up. In London, since the pandemic, rents have reportedly dropped by as much 14% in some of the more expensive areas. Remember also that during void periods, where a property lays empty, you need to be prepared to receive no rental income at all.
Some stocks and bonds pay annual or even quarterly dividends. Other funds or investment trusts pay out monthly or quarterly to their members.
Pensions aren’t subject to void periods, but investors do still have to consider factors such as whether a company they’re investing in can keep paying its dividend.
The average house price has nearly tripled since 2000[1]. Cashing in at the right time – either selling your second home or downsizing to a smaller property – can free up valuable equity for retirement.
But there are two things to consider:
1) Sell at the wrong time and you could end up with less than you’d hoped. Remember the UK property boom and bust in 2007/08? Many homes fell dramatically in value – and some have still not fully recovered.
2) Property isn’t as liquid as other investments. Unlike a traditional portfolio made up of stocks and bonds, a property investment can’t be gradually sold down to cash. This means you may have value locked up in your second home that’s difficult to access when you most need it. That said, there is the option to release equity in your home, particularly if you’ve already paid off your mortgage.
Bonds and stocks are more liquid, meaning you have faster access to capital. It’s also possible to sell down these portfolios in smaller chunks, allowing the rest of your investment to keep growing.
Just like the housing market, other investments are prone to slumps. However, there are more options to diversify – spreading your capital across equities in different sectors and bonds helps spread the risk.
One of the most important areas to look at in property investing is how much it will cost you.
A property investor has to manage conveyancing and legal fees. Then there’s maintenance, and management costs. A lot will depend on how ‘hands on’ you want to be. If you’re not prepared to be on call to resolve issues such as repairs, then you’ll need to pay a property agent to manage day-to-day issues.
And then of course, there’s tax.
You’ll pay income tax on rental income (which varies depending on your tax banding), stamp duty, and capital gains tax when you decide to sell. Tax relief is also a lot less for property owners than it once was – and don’t forget that your property could also be subject to inheritance tax (IHT).
Investment funds also come with charges (such as management or performance fees) which can be something of a hidden cost for investors.
Pension contributions benefit from tax relief, with no income or capital gains tax chargeable. You can also get tax relief on what you pay in and, once you reach 55, you can take out up to 25% of your pot as a tax-free cash lump sum. (The minimum age to commence pension benefits is subject to change and is expected to be age 57 with effect from 6 April 2028. Transitional arrangements may also apply.)
Pensions are also usually exempt from IHT.
Of course, one of the main attractions of owning a second home isn’t even financial.
Part of the appeal for many is the opportunity to own a tangible asset, not just something on a piece of paper. And it’s one that you can get real enjoyment out of too – after all, other investments don’t give you the option of a nice weekend break.
So what are the most important points to consider when making property part of your long-term investment strategy? As with any financial decision, it’s vital to consider everything in the round. See how you can diversify your assets, make sure all your investments are aligned with your personal goals, and take advice on how the next steps might affect you.
Give us a ring if you’d like to know more.
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[1] Source: Land registry http://landregistry.data.gov.uk/id/region/united-kingdom
This guide is for information purposes and does not constitute financial advice, which should be based on your individual circumstances.
A pension is a long-term investment, the value of your investment and the income from it may go down as well as up. Your eventual income may depend upon the size of the fund at retirement, future interest rates and tax legislation.
Levels and bases of, and reliefs from taxation are subject to change and their value depends on the individual circumstances of the investor.
Your pension income could also be affected by the interest rates at the time you take your benefits. The tax implications of pension withdrawals will be based on your individual circumstances, tax legislation and regulation which are subject to change in the future.
