Why bother with buy-to-let when you could get a 4%+ yield from the FTSE 100?

Hand holding pound notes

With the FTSE 100 having fallen by over 10% in the last six months, the index now has a dividend yield of 4.4%. This is historically high and shows that investors are relatively cautious about its outlook. It may also suggest that it offers good value for money, with there being the potential for rising dividends in the long run.

At the same time, the prospects for the buy-to-let industry seem to be relatively downbeat. House prices may prove to be unaffordable given the uncertain outlook for the UK economy, while tax changes and mortgage availability could reduce the sector’s appeal. As such, buying the FTSE 100 could be a better way of generating an increasing income return in the long run.

Growth potential

While the UK economy may experience further challenges in the coming months as Brexit moves ahead, the FTSE 100 generates 75% of its income from international markets. This means that it could stand to benefit from uncertainty surrounding the UK economy, with its constituents potentially enjoying a positive currency translation if they report in sterling but operate mostly abroad.

As well as this, the outlook for the global economy remains sound. Certainly, there are risks from a rising US interest rate and the potential for further US and Chinese tariffs. But with the major economies of the world generally growing at a fast pace, a number of FTSE 100 shares may enjoy improving profitability. This could help to lift the income return of the index over the next few years.

Uncertain future

In contrast, the outlook for the buy-to-let segment seems to be uncertain. Rental growth could be somewhat limited as a result of a weak outlook for the UK economy. There have already been downgrades to the UK’s economic outlook, and this trend could continue as the uncertainty surrounding Brexit looks set to build.

Alongside this, being a landlord is becoming more difficult. The government’s tax changes in areas such as stamp duty and mortgage interest relief are set to reduce the profitability of the segment. Increasingly onerous mortgage rules could also hurt the returns available to buy-to-let investors at a time when interest rate rises may be ahead. Given the rise in house prices of recent years, there is also a good chance that in many areas of the UK the rental yields on residential properties are not as high as the yield of the FTSE 100.

Outlook

With the FTSE 100 seemingly cheap and having the potential to grow its income return due to the strength of the world economy, it seems to offer a compelling investment proposition in my opinion. It provides exposure to a variety of economies across the world and has a track record of growth in the long run.

Buy-to-let has enjoyed a strong performance in the past. However, a combination of a weak outlook for the UK economy, valuation issues and tax changes could make it relatively unappealing compared to the FTSE 100.

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Peter Stephens has no position in any of the shares 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.

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