Think twice before relying on property over a pension

Investors relying on their property to fund their retirement were given a boost last week when the chief economist of the Bank of England suggested they were doing the right thing.
Andy Haldane said he didnt understand the pension system. Picture: Neil HannaAndy Haldane said he didnt understand the pension system. Picture: Neil Hanna
Andy Haldane said he didnt understand the pension system. Picture: Neil Hanna

But Andy Haldane, also a member of the Bank’s Monetary Policy Committee, is wrong, according to financial advisers who say investors overlooking pensions and instead banking on property are making a big mistake.

The debate as to whether pensions or property offer a better basis for retirement plans was reignited when Haldane said property “was almost certainly” a better bet for retirement planning than a pension.

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“As long as we continue not to build anything like as many houses in this country as we need to… we will see what we’ve had for the better part of a generation, which is house prices relentlessly heading north,” he said.

Haldane, who admitted earlier this year to “not being able to make the remotest sense of pensions”, had a point. House prices have risen in recent times, driven up by factors including low house-building levels and rock-bottom interest rates. That has also pushed rental prices up, supporting the rental yields enjoyed by buy-to-let investors. Whether you’re planning on selling your home for a lump sum to fund your retirement or using rental properties to provide a pension income, the case is a compelling one.

But while rising prices have made property more appealing, investing in property is a risky strategy for retirement funding.

“Borrowing money to invest is particularly risky because if the investment falls in value you still owe the bank the original value of the loan,” said Adrian Lowcock, investment director at Architas.

“As property becomes increasingly expensive and valuations rise, so do the risks. Investors should be wary of history repeating itself, especially as people’s income has not kept pace with property prices.”

Direct comparison between pensions and property is difficult, but there are proxies that can be used as a guidance.

Alan Miller, chief investment officer at SCM Direct, compared the returns from equities with the growth in house prices. Using the FTSE All Share to represent equity investments and the Nationwide All Houses price index to represent property, he found that between January 1986 and June 2016, UK shares generated annualised returns of 9.5 per cent, against 5.9 per cent for UK houses.

He also compared the returns of UK house prices with UK share prices over every quarterly 20-year period since 1986 and worked out the chances of shares beating property in each market.

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The average outperformance of UK equities against UK house prices over 20 years (based on 43 quarterly 20-year time periods since the start of 1986) was 184 per cent, with shares beating houses in 91 per cent of those time periods

“Maybe Mr Haldane, as a trained economist, should look at the data before making damaging and irresponsible comments and conclusions,” said Miller.

“Of course, he might say that this was the past and it will be different in the future – however, given the statistics on house price data against incomes, it is hard not to conclude that UK house prices are already ridiculously over-valued.”

Lowcock at Architas took a different approach, looking at the pension that could be generated from the funds required to buy a property. First-time buyers purchasing a home at the current UK average price of £204,238 (according to Nationwide) fork out at least £25,000 for a deposit and pay £10,000 a year over 25 years in mortgage costs (based on interest charges of 3 per cent).

If the property grew in value by 5 per cent a year it would be worth £692,252 after 25 years. But a 5 per cent annual return would give a 40 per cent taxpayer a pension worth more than £853,000 after 25 years, if they invested the same amount at the outset and then made contributions matching the mortgage costs for the average property. The difference reflects the tax relief available on pension contributions, he explained.

“A 40 per cent taxpayer gets an extra boost to their savings which makes a significant difference over time. The pension could also benefit from any income being reinvested, whereas rental income from a property cannot be reinvested into the property,” said Lowcock.

“If reinvested income is taken into consideration the gap between the pension and the property might be considerably larger.”

None of that means investors should steer clear of using property to help fund their retirement plans. Pensions and property each have their pros and cons, but the most sensible approach is to benefit from the diversification you get from investing in both, said Trent Lyons, financial analyst at Chiene + Tait Financial Planning in Edinburgh.

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“Pensions should not be excluded as they offer full flexibility as part of a robust and strategic retirement investment portfolio. Commercial property assets can, of course, be held as part of any pension investment strategy,” he explained.

“While further investment in a buy-to-let property can also provide a steady retirement income stream through rental income, I would tend to advise people to do this alongside a wider portfolio, including a pension, to minimise their exposure to risk.”