Over the past few decades, buy-to-let investing has generated a tremendous amount of wealth for investors.
According to the Office for National Statistics, over the past 10 years, the average house price in the UK has grown at a compound annual rate of 3.1% from £168,000 to £228,000. Including an average annual rental yield of 5%, this indicates that the average buy-to-let investor has seen a yearly return of 8.1% since October 2008.
These are just estimates based on averages. The actual return achieved by individual investors will vary greatly because there are so many different factors to consider here like mortgage rates, maintenance costs and taxes.
The end of buy-to-let
But as I noted at the beginning of October, the glory days of buy-to-let seem to be behind us.
My figures show that after including the impact of the government’s recent tax changes and slowing home price growth, buy-to-let investors getting into the market today will be lucky to walk away with an annual rental yield of 3.4%, excluding mortgage costs. Capital growth is also likely to be much lower over the next decade than it has been during the prior one. All in all, I estimate buy-to-let investing could produce a 6% annual return for investors getting into the market today.
A return of 6% per annum does not seem like much, especially as this does not include mortgage costs or the cost of property maintenance. But never fear, if you are worried about this low level of return, there is one simple trick you can employ to improve your investment returns.
Diversify, diversify, diversify
The way I see it, the biggest problem with buy-to-let investing is diversification. If you only own one or two properties, it won’t take much for your returns to evaporate. A property sitting empty for a few months or a broken boiler could eliminate a year’s worth of rental profits.
The solution to this problem is to increase diversification, but for most investors, this option is not available. Adding an extra five properties to your portfolio at today’s prices would cost around £1.1m (on average).
With this being the case, I believe the best solution to the diversification problem is to invest rental profits in equities. If you invest your income from rental properties into the stock market, you can achieve diversification and an extra passive income stream, that requires almost no extra work on your part.
Over the past decade, the FTSE 250 has produced an average annual return for investors in the high single-digits. Buy-to-let investing has matched this return since 2008, however, with returns set to fall going forward, I believe the FTSE 250 will outperform property. And, because you can own a FTSE 250 tracker fund inside an ISA, you don’t have to worry about the impact of tax (or changes to the tax regime) on returns.
Overall, if you want to improve your returns from buy-to-let investing, diversifying into equities could be the best decision you will make, I believe.
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Rupert Hargreaves owns no share mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.