HUNDREDS of thousands of people have invested in residential property for their retirement, and government proposals are set to boost the attractions of buy-to-let.

Gordon Brown has announced plans to let pension funds invest in residential property from April 2005. At the moment, they can hold only commercial premises. Any rental income and capital growth from a buy-to-let would be free of tax within a pension fund (see article, right).

But should you invest in property for retirement? Experts fear some buy-to-let investors may have underestimated the risks and overestimated the potential returns.

The FTSE All-Share index dived nearly 42% in the three years to the end of 2002, while property prices surged by 47% over the same period.

Many buy-to-let investors are counting on robust house-price growth in future. They often have interest-only mortgages and hope any capital growth will clear their loan at the end of the term. In many cases, they have a portfolio of properties and intend to sell some to pay off the mortgages on the others when they retire. The rent from the remaining properties will then provide an income when they stop work.

But economists expect the housing market to cool off over the next few years, so buy-to-let investors should not expect the spectacular gains of the past to continue indefinitely.

Annual house-price growth peaked at 28% in November last year and has since eased to 14%, according to Halifax, the bank. It predicts that growth will slacken further to an average of 8% by the end of 2004.

Some parts of the country are expected to be more buoyant than others. Halifax is forecasting growth of 17% in the north next year, compared with only 3% in the southeast.

Other analysts are predicting a sharper slowdown. FPD Savills, a property consultant, thinks prices will rise by an average of only 4% in 2004 and 10% over the next three years.

Richard Donnell of Savills said: “Britain’s housing market is entering a low-growth phase that could last several years due to rising interest rates, slower growth in household income and limited demand from first-time buyers. Buy-to-let investors should not overestimate returns.”

Some experts think that shares will beat property over the long term. John Lawson of Standard Life, an insurer, said: “Investors have been getting into property at a time when the market is hot and there must be a concern that some have overpaid. If so, there is a risk that prices will drop, or at least that growth will be lower than expected. Equities have lagged behind property over the past four years, but there are signs of recovery. Shares should provide superior returns over the long term.”

Equities have risen by an average of 10.7% a year over the past 50 years, according to Gerrard, the stockbroker. This compares with 8.8% a year from property, according to Nationwide building society. These figures do not include dividends or rental income.

Some buy-to-let investors may also be overestimating their rental income. The average rental yield — which shows the income as a proportion of price — is just 4.4%, according to the Royal Institution of Chartered Surveyors (RICS). So an investor with a property worth £100,000 might get an income of £4,400 a year.