08 June 2017
Continuing the property vs. pension debate
Evidence in support of pensions is growing.
by Frank O’Nomics
It is some time since I wrote about the property vs. pensions debate in these columns. The last time I did so, the arguments favouring pensions were not universally accepted, and many continued to prefer investing in property via the buy‑to‑let market, the hope being that this would provide a better long‑term income. However, recent data, including evaluations of the wealth committed to property and pension assets since 2008, suggests that some were persuaded by the case for pensions; also that returns have justified their choice. It is time to reopen the debate.
Perhaps because of difficulties in affording a property, money has been going into pensions at a high rate, attracted by tax advantages which, despite being eroded for high‑earners, are still very attractive for most. As a result of this, and some impressive growth in the value of pension assets, recent research by the Centre for Economic and Business Research puts the rise in the amount of money held in pensions in the UK since the financial crash in 2008 above the rise in the amount held in property. Given sluggish property price growth in the north of the country this may not be surprising, but the assertion holds even for London, where household property wealth rose by 50% and pension wealth by 52% in the period from 2008 to 2016. While some of the move may be down to more cash being invested in pensions rather than greater returns, this hardly seems true when one looks at other areas of the country. Even in the south‑east overall pension wealth grew by way more than property wealth, up by 92% against 22%, and when one looks at Scotland the changes are arguably even more emphatic, with property wealth actually down 4% and pension wealth up 24%.
You could argue that the authors of the CEBR report have been very selective about choosing their dates, given the low levels that equity markets hit during the crash – by starting in 2008 their pension wealth data benefits from a significant and rapid bounce in asset valuations. It is also fair to argue that the two areas are not unconnected, with many pension funds having a reasonable exposure to property over the period. Regardless of selective data use, the key issue in looking at why pensions have outperformed is what is likely to happen from here.
Critics of the CEBR report will fall back on the standard arguments that support property prices in the UK, particularly the inability of housing supply to keep pace with demand. Many analysts will argue that equities and bonds are overvalued and that a housing market bubble can be sustained much more readily given the low supply. This, however, might prove to be a very dangerous argument. While land may be the one thing that we cannot produce more of, only 10% of the UK has actually been developed. Overtime there is scope for supply to begin to match demand and the development of build‑to‑rent schemes looks like being one more factor that will undermine the level of property yields. The demand for buy‑to‑let property has been notably diminishing, helped by the introduction of 3% additional stamp duty, tighter lending conditions imposed by the Prudential Regulation Authority and the scaling back of tax relief on buy‑to‑let mortgages. This demand could be eroded still further by the decline in rental yields. A report this week showed that the cost of renting in Britain has fallen for the first time since 2009. The fall is only 0.3%y/y but it is widespread and more pronounced in London (at -3%). Rents hit their peak of affordability last summer, but low wage growth, rising inflation and economic uncertainty is restricting what landlords can charge. The number of properties on the books of lettings agencies has risen from an average of 169 a year ago to 183 now and there has been a rise in the number of landlords selling properties.
What about the prospects for pensions? Again, most of the asset classes utilised by a typical pension fund look distinctly overvalued, but the tax benefits still make investing in a pension attractive to most people. For a basic rate taxpayer the government adds 20% to pension contributions, and for the higher rate taxpayer the additional tax can be reclaimed, although the maximum annual allowance is £40,000. It is worth noting that, £40,000 is around the annual figure required to support a mortgage of £800,000. To the tax incentives should be added the long‑term benefits of having a spread of investments (rather than being exposed to just one asset class) and the ease of reinvesting income flows (something that is difficult to do with rents), a factor so crucial in terms of generating compounding effects.
On Election Day, perhaps more than any other, there is a key additional factor to bear in mind. All of the parties’ manifestos include spending promises that will need to be funded, and there is a limit to the extent to which this can be done by raising taxes. As a result it seems very likely that, once again, the tax advantages of pensions will be eroded at some stage. If, at this point, housing has become more affordable, we may have to revisit the property vs. pensions debate yet again.
If you enjoyed this article please share it using the buttons above.
Please click here if you would like a weekly email on publication of the ShawSheet
