Opportunity or loss?

Refilwe Modise asks whether pensions or property makes the better investment choice

Opportunity or loss?

The choice between where to invest in the long run depends on the concept of opportunity cost. You can’t have more of one thing without sacrificing the other. As such, we could pose the question, “What is the right choice in long-term investment? Investment in pensions or in property?”

A property purchase requires a substantial initial expenditure. Pensions, however, allow you to save for retirement through monthly payments – which most people may be able to do. One commonly-used option to combat the problem with property investment is to use mortgages.

In the UK, one is allowed a mortgage of up to three to five times their salary. Taking a mortgage means one can purchase property and sell it at a higher price for capital gains; the average house price went from £58,000 in April 1990 to £225,000 in February 2018.

The combination of rental yields and capital growth means there is both immediate income and the potential for long-term profit. Nonetheless, according to the ONS, “Average house prices in the UK increased by 0.7% in the year to July 2019, down from 1.4% in June 2019. This is the lowest annual rate since September 2012, when it was 0.4%.

“During the past three years, there has been a general slowdown in UK house price growth, driven mainly by a slowdown in the south and east of England.”

This trend of downward increases in house prices means one would have to hold property for longer in order to raise a substantial profit.

Timescales to sell could differ due to demand and supply issues – and negotiations. Many landlords opt to hold the property for some time and buy-to-let. Rental yields can be used to cover-off interest payments from the mortgage over a few years. The house could then be sold for a profit and the revenue generated used to pay off the initial mortgage.

Repeating this process on a large scale can lead to exceptionally high investment gains. Yet such ventures also lead to advertising costs, as well as the renovation and management costs of renting out property.

Mortgages are also dependent on occupation type and income, which act as limiting factors on how much you can actually make from the ‘mortgage, buy and sell’ option. In recent years, regulation changes have meant that the tax on property is more belligerent than on pension income. For those opting to invest in property rather than a pension, what happens in the late stages of life with regard to property management? One of two things could happen, either assistance from family or using letting agencies to manage them, although the latter comes at a cost.  

Pensions secured in DB schemes are often low-risk due to the backing of the central discontinuance fund in the UK. However, if your employer goes bust before you retire and you hold a defined benefit pension, you may lose up to 10% of your pension value. The likelihood of this is fairly low, though, so pensions are a good option for the low-risk and additional contributions that come with it. DC schemes, on the other hand, allow the individual to tailor the contribution investment to align with their own risk appetite. Risk is also limited within a pension by the fact that you are only investing money you have – so you cannot lose more than you invest. By contrast, people borrow to buy property, which will magnify their return on their investment during good times, butleave them in financial problemsduring bad times.

Essentially, it all depends on your risk appetite, circumstances and expertise. With regards to pensions versus property, the key question is: how much risk do I want to take? While the risk-averse may shield their funds using low-risk assets, real yields in the UK on government bonds have been negative for a while now. Therefore property, or, by proxy, property funds, can be the necessary device to push up risk-adjusted returns without facing  stock market volatility head on.

Refilwe Modise is a guest student editor

Picture Credit | Simon Scarsbrook