People love property. There is something about purchasing a house or flat, being able to walk its rooms and decide its decor, that is immediate and tangible. Because we all need a place to live, it’s much easier to understand as an investment compared to your standard investment portfolio of stocks and bonds.

However, if you have a lump sum to put to work, physical property is not necessarily a better choice than building an investment portfolio, for a host of reasons. So which should you pick?

Returns

One obvious question is: which option will make you more money? This is hard to answer, even if we take past returns as a starting point (not always the best idea).

When comparing asset classes or funds, it’s commonplace to use total returns over certain time periods. But working out the total returns of a buy-to-let property is more complicated, as the results vary hugely depending on the property’s features, the area and your personal circumstances. 

Still, we can get a broad idea. Hamptons estimates that someone who bought an average property in England or Wales in 2014, and rented it out for a decade before selling it, would have made a total return (including both capital gains and rental income) of 105 per cent before costs, or 86 per cent after. This varies across areas, with the most lucrative being the north-west (120 per cent after costs) and the least lucrative being London (65 per cent).

The net figures are based on the assumption that 31 per cent of a landlord’s rental income goes towards their costs – which may seem high, but is based on HMRC tax returns. It’s easy to underestimate these figures, but things such as repairs, estate agent fees and legal fees, among others, add up very quickly. Importantly, the calculations also assume you buy the property with cash and not using a buy-to-let mortgage. 

The chart below shows how the performance of the average buy-to-let over the past 10 years compares to other asset classes. 

It’s a mixed picture. Unsurprisingly, the typical buy-to-let has not kept pace with global equities, but its returns are roughly in line with those of the UK market, and significantly better than those offered by UK government bonds or London-listed real estate investment trusts (Reits). 

It is worth keeping in mind that with base rates on a downward path, the outlook for bonds has now much improved. And not all Reits have done poorly – the biggest component of the index, Segro (SGRO), returned 137.8 per cent over the past decade. But overall, past returns for BTL look fairly decent.

Taxes and practicalities

However, when practicalities are factored in, the investment case for physical property gets more complicated. One of the asset class’s main advantages is that you can boost your returns by borrowing to invest, which is a riskier prospect when it comes to equities – although clearly buy-to-let borrowing also comes with risks, including that of defaulting on the mortgage. But while over the past 10 years the cost of a mortgage has been very low, this is no longer the case, so that boosting effect is much reduced.

Another advantage of physical property is that its value tends to be less volatile; the price of stocks or Reits tends to fluctuate more regularly and more quickly.

But the counterpoint to this argument is that physical property is illiquid. A flat or house can take months to sell, so you won’t be able to access the capital quickly if you need to, and must have a long time horizon for your money. This is of course also recommended with equities, but in an emergency, you can almost always sell a portfolio of shares – even though you risk losing money. The liquidity is at least available, and you can opt to liquidate a portion of the portfolio as an alternative. These are not regular options with a house or flat.

Then you have taxes. If you hold an investment portfolio in an individual savings account, all income and gains are tax-free. With buy-to-let, you have additional stamp duty to pay upon purchase (the additional rate increased to 5 per cent from 3 per cent on 31 October 2024); rental income is then subject to income tax (potentially up to 45 per cent) and any gains you make when you sell up are subject to capital gains tax (CGT) at up to 24 per cent. We have discussed at length how the combination of higher interest rates, higher taxes and increased regulations has hurt the sector over the past few years.  

The additional hassle of managing a property is worth keeping in mind. You may enjoy having a personal relationship with your tenant and being hands-on with your investment; or you may prefer the ease of checking your portfolio online a few times a year, without having to worry about things like repairs. You also have to consider that your property might periodically be empty for a few weeks if your tenants leave and you need to find new ones, eating into your returns.

If you invest in buy-to-let, you almost always end up allocating a very significant portion of your portfolio to residential property – although to an extent this depends on how much wealth you have overall. Meanwhile, a liquid portfolio allows for diversification, both within property as an asset class and more broadly. Laith Khalaf, head of investment analysis at AJ Bell, says it is perfectly possible to have a portfolio that does not include property at all, and that the asset class should generally make up between 0 and 10 per cent of a balanced multi-asset portfolio. If you sell your buy-to-let, it makes sense to reallocate the sum across various asset classes depending on your goals and time horizon; you can leave a small percentage for Reits if you want to keep a more liquid and flexible property allocation.

Reits offer broader diversification, a bigger focus on commercial property and exposure to less obvious sectors. More esoteric examples include Unite (UTG), which specialises in student lets, or Tritax Big Box (BBOX), which provides distribution infrastructure. Elliott Frost, investment manager at Lumin Wealth, says that investors can use Reits “to allocate across sub-sectors, maintaining a diversified allocation. Combining this with a legal requirement for Reits to consist of three or more properties, with one not exceeding 40 per cent of the total value, means individuals will likely always have less asset risk”.

Even if income is your main focus, a diversified portfolio is likely to be your best bet. “Income is the characteristic that draws most investors into property, with yields being highly competitive and inflation linkage common. Reits often have long-term lease agreements with tenants (15+ years), which makes rental income and dividends paid relatively reliable,” Frost explains. But this depends on the tenant; aside from the advantage of spreading your risk across different occupiers, this strategy is not necessarily more reliable than a tenant renting your buy-to-let.  Despite their income focus, Reits can cut or cancel dividends, as many did in 2020.