Key points
- Many investors turn to buy-to-let properties to generate a passive income
- I believe this is a mistake due to the costs and risks involved
- Stocks and shares may produce better returns with less work
Some investors believe buy-to-let property is an excellent way to generate a passive income. While it is true that many have made a lot of money using this approach, it is not something I plan to follow.
In my opinion, there are three reasons why investing in rental properties is not as attractive for me personally as owning stocks and shares.
Buy-to-let property drawbacks
First of all, there is the amount of investment required. With the average UK property price now standing over £260,000, I would either need a large lump sum or a large mortgage to buy a rental home. By comparison, I only need a few pounds to invest in equities.
Then there is the cost of owning a buy-to-let property. Mortgage and stamp duty rates are higher for rental investors than homeowners, and there will be an annual running cost. That is without considering the cost of finding tenants in the first place. I might have to pay a fund management fee or investment platform fee with stocks and shares, but these are relatively small and predictable in comparison.
And finally, there is the time required. Buy-to-let property is not a passive investment, contrary to widespread belief. Owning a rental property is a business. Like any business, it requires time and effort to make it work.
On the other hand, when I buy shares in a corporation, I am also investing in the time and effort of the company’s managers. They look after the business on behalf of all shareholders. There is no need for me to lift a finger.
Despite the drawbacks of buy-to-let, this asset class does have some benefits. Property prices have outperformed inflation in the long run. There is also a fairly steady demand for rental homes, suggesting investors will always be able to achieve an income stream.
For investors with the right skills, buy-to-let could be the right choice.
Growth opportunities
But rather than buying property, I prefer to invest in stocks and shares. I am buying shares in companies with global diversification and portfolios of leading brands. These are two other factors I would not be able to achieve with rental property.
Without millions of pounds, it would be impossible for me to build a well-diversified portfolio. It would also be impossible for me to create an international property portfolio.
One of the companies that I already own in place of rental property is Diageo. This enterprise owns a portfolio of globally-recognised alcohol brands and is managed by a team of experienced individuals.
The one downside of buying individual stocks and shares compared to buy-to-let property is that I have no control over how the companies operate. In this respect, rental property does provide the better option, but it also comes with more work.
If I wanted to diversify into property, I would buy shares in a property manager such a Grainger, one of the UK’s largest professional landlords. This would provide diversification without exposing me to some of the risks above.
Rupert Hargreaves owns Diageo. The Motley Fool UK has recommended Diageo. 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.
