The rules and regulations covering pensions are changing in April, and new pensioners will have a great deal more freedom in how and where to invest their pension pots. One avenue that some people will be looking at closely is the buy-to-let market. At first glance, rental revenue could be more attractive than buying an annuity, but there are a range of conflicting views about what will happen when the new regulations come into force. Whatever the case, becoming a landlord certainly seems to be attracting interest.
A COSTLY BUSINESS
It seems likely, however, that a lot of 'silver landlords' will fall foul of the many pitfalls that go with the rental market. Buy-to-let is now a regulated sector, and there are many legal requirements imposed on a landlord that even the most experienced can sometimes find daunting. Non-regulated responsibilities can also eat away at rental income. You also have to decide where you wish to locate your property. The ideal location would be somewhere close to where you already live, but this is not always possible, for a number of reasons. There are a range of options. Most aspiring landlords will want to keep on living where they are and buy another property. But there are other avenues open. Neil Woodhead of Ready Rentals, an online support service for private landlords, cited the case of one client in Scotland who sold his rental property - a modern flat, bought originally for £110,000 - for £160,000, and bought two single-bedroom flats for £28,000 each. The point here is that the monthly £550 rent on the modern flat grew to £730 for the two smaller flats combined.
Using some of your own capital in your house can increase your options and reduce the need to top up any house purchase with a mortgage. Where this is not possible, the seed capital can come from your pension. But if you want to release more than a quarter, remember, you are liable for income tax, which will blow a big hole in your accumulated funds. But just taking the tax-free element is unlikely to free up sufficient capital. One alternative is to raise funds through a buy-to-let mortgage. Up until recently, this has been a virtual non-starter for someone aged 65, but lenders are already having second thoughts about whether to revise their lending policies. At the Mortgage Works, part of the Nationwide Building Society, pensioners under the age of 70 can apply for a mortgage with a repayment period of anything up to 35 years. Using equity release as a source of top-up funds is altogether more viable. But those funds will have to come from existing properties or other accumulated funds. However, it might make sense to take a step back ahead of the April changes because annuity providers are still working on how to pull funds back into the sector, and it may well be that we will see a flurry of hybrid-style products that combine investment drawdown with annuity elements.
IT'S ALL ABOUT THE MATHS
It's important to get the arithmetic right. For most aspiring landlords the numbers simply won't stack up. For example, take a £150,000 flat within an hour of London. Rates vary, but you can reckon on charging around £650 per month in rent. That works out at a yield of 5.2 per cent. Assuming property values are not at the top of the cycle, there will be an element of capital appreciation in this too, although this will not be crystallised unless the property is sold. If you took out a £75,000 mortgage at 5 per cent, this will cost around £310 per month for an interest-only mortgage, or £3,720 a year. That's a net £4,080 return for your £75,000, or 5.4 per cent on the £75,000 invested. Either way the return is before income tax, maintenance costs, legal fees and agency fees. But this is a guide only. You could find a cheaper property, perhaps one for £120,000 that needs refurbishment, and the returns could be a lot better if you buy in a regional city with ready-made demand, from a university for example.
Essentially, building up a profitable buy-to-let portfolio takes time, more time perhaps than many pensioners have at their disposal. It's also worth reflecting on the financial pain meted out to a large number of one-property landlords during the financial crash seven years ago. You can withdraw from liquid investments such as equities with some speed. That's not the case with a house, especially when the tenant has left and the value of the house is falling. And given the relatively small amount of tax-free capital that could be crystallised from the vast majority of pension pots, becoming a landlord is probably not really an option for the majority. If in doubt, do nothing until the scrum dies away after April.
THE REIT PATH
If the path to becoming a landlord is too arduous, there is an alternative, albeit one that carries more risk, and that is to invest some of your pension fund in a publicly quoted property company. Specifically, real-estate investment trusts (Reits) generate revenue from the rent raised from a property portfolio, or, in the case of a mortgage Reit, from the interest generated on mortgage loans. For shareholders, for that is what you would be if you bought the shares, the advantages include a significantly higher dividend yield. To achieve Reit status, a company is required to distribute at least 90 per cent of their taxable income for each accounting period back to investors. The advantage for the property company is that it pays no corporation or capital gains on the profits made from property investment. The downside is that Reits are more volatile than direct property investments, and behave more in line with equities. In the longer term, however, their performance is more closely correlated with property than equities.