The property market has been in boom times ever since the end of the financial crisis. A chronic housing shortage, ultra-low interest rates and government stimulus schemes have all helped to deliver exceptional returns from bricks and mortar in the last 10 to 15 years.

The average house price has risen from £168,400 in 2012 to £283,500 today, according to ONS data. That’s a handsome return of just over 5% a year, before even accounting for any income generated.

The thriving property market has clearly led some savers to turn to buy-to-let to help fund their retirement, but the immediate future for house prices is not looking quite so rosy, with interest rates on the rise and recession in the post.

Nevertheless, it’s hard to make a case that prices won’t rise over a reasonable time frame, given there is a chronic shortage of housing in the UK.

How that compares with other investment options is difficult to forecast, but over the last 10 years, the global stock market, as measured by the MSCI World index in pounds and pence, has risen by more than 10% a year since. That’s double the price appreciation of the average UK property.

The stock market is more volatile and will tend to fall further and faster in times of stress, but it will often outperform property. However, the returns from housing versus other assets is just the tip of the iceberg in terms of what property investors need to consider.

The risks and returns of leverage

Many property investors choose to boost returns by borrowing money from the bank to fund their purchase. This can amplify profits, because the debt stays level while house prices typically increase, and the rental income generally covers interest payments.

But this dynamic works in reverse if property prices fall. Your debt doesn’t shrink, even though the asset you own has fallen in value.

Looking at historical data, a 20% drop in property prices is possible in housing market busts. If you’re able to hold on for the long term, prices will almost certainly recover.

But another risk from mortgage borrowing is that interest rates rise, and your payments become unaffordable, or perhaps more likely, uneconomical. The extremely low interest rates we have seen for the last decade mean the rental received by buy-to-let borrowers has in most cases exceeded the interest paid on their borrowing. As interest rates rise though, that financial equation might not look so benign.

The high costs of holding property

There are other punitive costs which need to be met, whether you have borrowed to invest in a property, or made a cash purchase. Legal fees, survey costs and stamp duty all take their toll on returns. Buy-to-let investors also face a 3% surcharge on top of normal rates of stamp duty, adding insult to injury.

There are ongoing maintenance costs, letting fees, landlord insurance and void periods to consider, which will also make a substantial dent in rental income, before factoring in any mortgage interest.

Looking at the rise in property prices and rental yields makes no allowance for all these costs, so it’s not an entirely fair reflection of the returns that have been harvested.

The stock market compares very favourably in terms of costs to property. You can buy a tracker fund for negligible transactions costs, and then typically pay less than 0.5% a year in fund and platform charges, so more of the returns feed through to your bottom line.

Taxing questions

Income and capital gains tax are also important to consider when weighing up a property investment. Rental income is taxed at your marginal rate of income tax, though you can deduct costs associated with running the property. This used to include the interest paid on a buy-to-let mortgage, but recent rule changes mean you can now only claim basic rate relief on that interest.

Capital gains on property sales are taxed at 18% or 28% for basic or higher rate taxpayers respectively, eight percentage points more than other assets. Unlike shares and funds, a residential property can’t be put inside a pension or ISA, which allow stock market investors to receive investment income and gains free of income and capital gains taxes.

You pay income tax on withdrawals from a pension, apart from 25% of its value, which you can take as a tax-free cash sum. However, you also receive tax relief on the contributions you make to a pension, and normally you’ll receive employer contributions too, making a pension an extremely effective way of building up a retirement pot.

The fact you can sell down bits of your pension, or ISA, also makes the income you receive more manageable in retirement. If you want to take a bit more in one year you can sell some of your investments and withdraw the proceeds. If you want to take a bit less in another year to minimise your tax liability, you can just leave investment income in the tax wrapper. When it comes to a property, you can’t generally sell bits of it, or turn the rental income taps on and off.

Using property as part of your retirement plan can be a successful venture, but it’s no walk in the park. For most people, using pensions and ISAs to save for retirement will be preferable in terms of returns, costs and tax, not to mention the hassle factor.

Nonetheless, the familiarity of bricks and mortar will no doubt mean buy-to-let property continues to be used for retirement income purposes. But even if you’re keen on this approach, make sure you do your homework and dive in with your eyes wide open, accounting for all the risks, costs and taxes first. Otherwise, you’re probably in for a few nasty shocks.

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