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The B2L challenge to pensions

With low interest rates affecting pension pots, there is an argument for buy-to-let to be marketed to clients as an alternative. John Greenwood examines the pension versus buy-to-let strategy

While interest in buy-to-let is starting to gain momentum once again, Britons’ affection for pensions stands at an all-time low. The double-digit returns enjoyed by many buy-to-let investors stand in stark contrast to the dismal performance experienced by most pension savers.

So as low interest rates punish pension investors with low annuity rates while supporting landlords with cheap borrowing costs, is it time for lenders to market buy-to-let as an alternative to a pension?

The two strategies could not be more different – a pension is a ’file and forget’ product that requires little or no personal input, is managed by professionals and attracts significant tax relief. Becoming a buy-to-let landlord on the other hand requires time, expertise and business acumen.

Yet comparing the returns the two strategies have reaped in recent years makes a compelling argument in favour of buy-to-let for anyone with the financial expertise to make it work.

Global property data firm IPD’s UK Residential Index tracks combined average returns rental income and property price increases for institutional property investments. It may only offer an approximation of the sorts of returns landlords have enjoyed, but it does reveal how thoroughly bricks and mortar has wiped the floor with other asset classes in the last decade.

Its 2011 figures have not yet been published, but in the 10 years to 2010, the so-called ’lost decade for equities’, the index shows residential property generating an inflation-adjusted return of 7.1% a year. That compares with just 0.8% a year for equities, which make up the bulk of the portfolios of most pension investors, 3% for gilts and 3.7% for commercial property.

The Association of Residential Lettings Agents’ Geared Investment Index shows even better annualised returns for buy-to-let landlords. That index, which takes into account rents achieved, capital appreciation as defined by house price inflation, buying and selling costs and likely mortgage costs based on a 25% deposit, shows a 21% return in the five years to Q3 2011.

And it is not just on investment returns that buy-to-let outshines pensions. While today’s low interest rate environment is benefiting borrowers, it is also hitting pensioners’ annuity rates hard. Low interest rates, compounded by lengthening lifespans, have pushed annuity rates so low that a 60 year old must hand over £100,000 to an insurance company to achieve an inflation-protected income of just £3,000 a year, according to Financial Services Authority figures.

Rental yields for those who manage to build up unencumbered investments could expect something approaching double that figure, plus the benefit of being able to pass on the asset to beneficiaries on death, rather than see it kept by the provider.

It is perhaps no surprise then that only 38% of people are saving in pension plans today, down from 46% a decade ago, according to the Department for Work and Pensions.

So does the UK’s negative view of pensions present the buy-to-let sector with an opportunity to come to retirement savers’ rescue? Bricks and mortar were pushed by some as an alternative to pensions before the financial crisis, but views are mixed on whether the strategy would work again this time around.

Ray Boulger, senior technical manager at John Charcol, believes the industry could see buy-to-let featuring as a pension alternative, but argues that it is unlikely lenders will put such a message at the heart of their direct marketing, instead opting for a more subtle approach.

He believes that if providers led a debate in newspapers, backed by specially-commissioned research showing the relative performance of buy-to-let versus returns on pension, they could begin to persuade the public that bricks and mortar is a realistic retirement strategy once again

“Buy-to-let is not regulated, and for regulated lenders to actively market something outside their regulated activities, they would run the risk of incurring the wrath of the FSA,” he says. “Rather than spend money on advertisements promoting the idea of buy-to-let as a pension replacement, the best way to bring the concept to the public is through well-reasoned articles in the national press. This could be done on the back of research showing the returns from buy-to-let and inviting comparisons with alternative long-term savings strategies.”

But others believe that lining up buy-to-let alongside pensions and comparing the two is a flawed strategy.

John Heron, managing director of Paragon Mortgages, could not be more emphatic about it.

“It is a dangerous error to consider pensions and buy-to-let on the same level,” he says. “Buy-to-let is a business. Clients have to have done their homework, not just on the property, but on understanding the rental market – and it is a market they are competing in. They have got to think about the obligations they are taking on and think about the customer service proposition they are going to offer.

“There is no question that buy-to-let has been an attractive asset class for investors. However, it cannot be considered in the same class as pension investing. The attraction of managed investments on the other hand is that they are directed by professionals, on the advice of a professional IFA, and they are protected by the quality of the professionals and the regulation that surrounds them.”

While lenders such as Paragon, which targets professional investors, would not see what might be described as amateur landlords as a potential growth market, others might take a different view.

Phil Rickards, head of sales at BM Solutions, is more relaxed about the idea of investors perceiving buy-to-let as a pension, although he sees it as supplementing other forms of pensions, rather than being the sole method of saving for retirement.

“Individuals prepare for retirement in different ways and what is a good investment for one person might not be the best course of action for another,” he says. “What we are seeing at BM Solutions, however, is that many do in fact look on property investment as a means of enhancing their pre-existing pension, rather than as a replacement for any other investments.”

In BM Solutions’ December Landlord Panel Study, 46% of its customers said they got involved in property letting to cash in their portfolio in the future to supplement their pension.

“And the rewards are certainly being delivered here – at an average of 6.7% across the market, rental yields are at a seven-year high,” Rickards adds.

Promoting buy-to-let as an alternative to pensions so soon after the financial crisis would carry potential reputational risks for lenders, but should any try, they should not expect the opposition to go down without a fight. Traditional retirement savings players will be ready to point out the potential flaws in property for retirement.

Tom McPhail, head of pensions research at Hargreaves Lansdown, points out that buy-to-let enjoys none of the generous tax relief available to pensions, which includes up to 50% relief on contributions, tax-free investment growth and a 25% tax free lump sum when income is drawn. He says void periods, liquidity, interest rate rises, problem tenants and unexpected expenses should be thrown into the mix too, not to mention the obvious benefit of matched employer contributions into a pension.

“Disentangling the differences between buy-to-let and pensions and presenting it as a like-for-like comparison is difficult,” says McPhail. “And for anyone who already owns their home, going for buy-to-let means putting all their eggs into the UK property market, which is a massive concentration of risk, before even factoring in the further increase in risk that they get by gearing their investment.

“You have conflicting dynamics in the market, so it is impossible to say property will perform as well over the next decade. Yes, cheap credit and an undersupply of property are creating excess demand, but prices are out of kilter with reality and there is the risk of an interest rate shock in the future.”

Despite this, the lure of residential property and the ability to fast-track your investment by quadrupling your stake through borrowing, mean the property as pension argument is never likely to disappear completely from the public’s psyche. But if any lenders do decide to put the concept into their marketing strategy they can expect criticism not just from pensions professionals, but from other lenders too.

“I would be shocked if lenders promoted buy-to-let as simple and something that could easily be compared with a managed investment scheme,” says Heron.

“In the boom years up to 2007 some lenders let things run ahead of themselves. The lending community, and I say this with my Paragon, Intermediary Mortgage Lenders Association and Council of Mortgage Lenders hats on, needs to be giving clear advice to buy-to-let landlords that this is a business investment.”

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