New legislation starting in April 2015 allows retirees to use their pension to buy property instead of an annuity. And the booming UK property market may find its appeal as a viable alternative to buying an annuity upon retirement.
But is it a good idea? And which is better?
Well there is no clear answer. It all depends upon the annuity rate offered upon retirement against the yield you can generate from a rental property. Whilst prices have started to rise again since the Help to Buy scheme was introduced, yields have fallen in response and are unlikely to catch up anytime soon - unless wages start rising in tandem.
Annuity rates have risen in the last year from around 5% to 6% - depending upon your age and the type of product purchased. But yields from rental property have fallen to just under 5% in the last six months.
And if property prices continue to rise, yields will fall even further. Like bonds, there‘s an inverse relationship between price and yield.
Rental property is only a good alternative if the yield - after all expenses including management, repairs, maintenance, tax, void periods and legal fees - is higher than annuity rates offered. Tempting as it may be to argue that capital appreciation should be included in this comparison, any reliance on price appreciation to plug the gap is speculation. Not investment. Plus Government intervention in the market with regulations or stimulus can move the market in either direction.
Investment in rental property has made many private landlords a lot of money over the last 18 years. However, those who profited the most entered the market during the mid-nineties when prices were below a price to income ratio of 3. Recovering from the recession of 1992-1993, property was cheap by historic standards. And rental yields were well above 10%. In some places in the UK, yields were close to 20%.
But today it’s a different story. Unless you can buy a property which offers at least a 50% spread between annuity rates and rental yields, then we would argue, you’re best off purchasing an annuity when you retire.
Of course, if you have more than 10 years to retirement, then property could be a sensible option providing there is room for plenty of price appreciation which can only be determined by comparing the long term historic price average in relation with prices today.
With thanks to Mark Mackay from Prime Asset Investments
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