Forget buy-to-let: I’d rather buy FTSE 100 dividend shares in an ISA

I think that FTSE 100 (INDEXFTSE:UKX) income shares offer a better risk/reward opportunity than a buy-to-let.

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Buy-to-let investments have proved to be a popular means of obtaining an attractive mix of income and capital growth in the past. UK house prices have generally moved higher over the last couple of decades, with rents doing likewise. Since obtaining a buy-to-let mortgage was fairly straightforward, and low interest rates have reduced the cost of borrowing, buy-to-let investments have been highly sought-after.

However, the prospects for buy-to-let investments appear to be relatively unfavourable when compared to those of FTSE 100 dividend shares. From an income return perspective, as well as the outlook for capital growth and risks, large-cap dividend shares could be more appealing.

Income prospects

Following the rise in property prices across the UK, obtaining a high yield on a buy-to-let investment is becoming more difficult. In addition, the difference between an investor’s gross yield and their net yield could widen over the medium term. Tax changes mean that it is no longer possible to offset mortgage interest payments against rental income for many landlords, which could hurt their cash flow.

By contrast, obtaining a 5%+ net yield from FTSE 100 shares is not especially challenging. When stocks are purchased through a Stocks and Shares ISA, there is no tax to pay on any dividends received or withdrawn. Since a quarter of FTSE 100 shares currently yield over 5%, generating an income return of that figure from a balanced portfolio of companies is unlikely to prove to be difficult for long-term investors.

Capital growth

The UK’s economic outlook continues to be uncertain. Political and economic risks may mean that house prices falls become increasingly commonplace, with them already having impacted on the London and South East property markets. A change in government may lead to different housing policies that cause properties to become less affordable to first-time buyers, while weak consumer sentiment may manifest itself in lower demand for housing as first-time buyers postpone what is a major financial decision.

The FTSE 100 also carries risks to its outlook. The world economy faces an uncertain period, with political risk in the US being high and the global trade war set to continue over the coming months. However, with the index’s members appearing to include wide margins of safety, it could be argued that their valuations take into account the challenges facing the global GDP growth rate. As such, the chances of generating strong capital returns from an investment in the FTSE 100 appear to be high over the long run.

Takeaway

Buy-to-let investments may have enjoyed a strong period over recent decades. However, a mix of tax changes, risks and valuation challenges mean that now may not be the right time to invest directly in property. By contrast, the FTSE 100 appears to be ripe for investment after a period of mixed performance. Its yield and capital return prospects mean that it could deliver high total returns over the long run.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Peter Stephens has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. 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.

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