Mark Dampier: Why buy-to-let flats are not an open invitation to achieve high yields
Friday 10 May 2013
This week I plan to focus on the investment landscape generally, rather than looking specifically at a single investment. I was inspired to do this following a conversation with a neighbour. He suggested I should look at a new development of flats near my office in Bristol which had just come on to the market. They were selling out fast, proving to be particularly popular with buy-to-let investors.
On closer inspection it wasn't hard to see why. One-bedroom units were selling for between £160,000 and £170,000 with a yield of approximately 6 per cent gross. Rates on cash deposit are around 1.5 per cent and could fall further in my view. Against this backdrop the attraction of a 6 per cent yield is obvious.
The mere fact I was even looking at property as an investment might be enough to make those that regularly follow my views fall off their chair backwards. They will know I have been a property bear for many years. Indeed, there are many factors to consider besides the attractive headline 6 per cent yield.
First, there are the costs associated with buying the property. Next, it is likely to need furnishing, while some form of landlord insurance might also be prudent. These costs alone are likely to eat up the first year's yield at least.
It must also be remembered that secondary property can be illiquid – it could be difficult to sell quickly if you require your capital back. Buy-to-lets can also suffer from periods of vacancy between tenants where no rent is coming in. Finally, there is general maintenance and repairs. If nothing more these can be a hassle, unless you pay an agent to manage the property on your behalf, incurring further costs to eat into the yield.
I am not against buy-to-let property as an investment. I can understand canny investors buying property in out-of-favour or poorer locations and being compensated with yields closer to 8 per cent. Unless you have been in central London over the past few years, though, property has not been a great investment. The prices of older flats around the same development I looked at have pretty much gone nowhere since 2007. Once inflation is factored in that's a loss of 25 per cent in real terms.
This brings me neatly back to the more familiar subject of equity investment. I was initially attracted to a yield of almost 6 per cent on the buy-to-let property investment, yet I can buy equity income funds yielding over 4 per cent and where I am likely to enjoy dividend growth, much lower transaction costs and considerably less hassle. In addition, equity investments are generally easier to buy and sell at short notice. I do have greater short-term volatility, but that is because equities are priced continuously throughout the trading day. With property volatility is disguised by a less than instant valuation process.
Finally, for those still tempted with an investment in property, I recently came across some analysis from Majedie Asset Management highlighting just how expensive alternative asset classes are. They have done this by using the price/earnings ratio (P/E ratio) to value different asset classes. This aims to measure how cheap or expensive they are relative to one another, with a high P/E ratio suggesting an asset class is expensive and vice versa.
On this basis the UK stock market is trading on a P/E ratio of 13x for the calendar year 2013 with a yield of 3.5 per cent, with the expectation this should rise slightly over the long term. In contrast, commercial property trades on a P/E multiple of approximately 25x (after costs). Infrastructure, which has proved popular with income-seeking investors, is trading on a multiple of 22x, while residential property is on 35x. Buying into relatively expensive assets just for the sake of diversification simply does not make sense to me.
If you think property and infrastructure look expensive I have a bigger shock for you. UK and US government bonds are trading on P/E ratios of 57x, and Japanese 10-year bonds are on P/E ratios of 200x. While investment decisions shouldn't be based on one metric alone, I hope this goes some way to putting any investment decisions in perspective.
Mark Dampier is head of research at Hargreaves Lansdown, the asset manager, financial adviser and stockbroker. For more details about the funds included in this column, visit www.hl.co.uk/independent
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