Property Investment

Property provides a combination of rental income and capital growth on the bricks and mortar.

Rental Income – Rental income can be a very healthy alternative to interest and dividends as it usually runs at between 5%-8% depending on the property and area.  The main disadvantage is that the property needs to be occupied  to charge a rent, if the area or market changes you could find that you have an empty property for some time.

Capital Growth – Property prices as we all know rise and fall, however they are less volatile than shares which rise and fall on a daily basis, property fluctuations tend to be a lot slower.  However that can not only mean a slow fall but a slow rise as well leaving you waiting for some time to make a profit or regain losses.

There are generally 2 ways to invest in property, directly or indirectly via a collective investment:

Directly – through the purchase of a commercial property or residential house or flat.  This is a large investment so most people will need to borrow via a mortgage of some sort.  These days investment property mortgages, including buy-to-lets, are dealt with as standalone deals which means that the rental income needs to be able to support the repayments

Indirectly – through collective investments which are pooled funds.  This means that you join with other investors to provide a large enough fund to make the investment and you own a small percentage of it pro rata to your investment.  These collective investments funds can be very large perhaps in the billions of pounds and often own large properties such shopping centres and office blocks. The following are examples:

• Real estate investment trusts (REITs) – these are pooled investment funds
• Shares in listed property companies – buying shares in companies that specialise in property development allows you to participate in their profits
• Property investment trusts – similar to REITs
• Insurance company property funds – these are funds that you invest in through your pension or life assurance policies. They are similar to REITs and Property Investment Trusts.
• Property unit trusts / OEICs – Again similar to REITs
• Land Banks – these are investments into land for development rather than property and tend to be high risk

Direct Investment:

Pros 

• The property is yours and if the returns are greater than the interest you are paying on any mortgage then you are making a profit on yours and the lenders money.
• It is a physical asset that has value and there is a strong history of profits in the UK.  As there is a housing shortage and it is difficult for people to get mortgages these days there is a thriving rental market.
• Some of the costs such as the interest can be offset against income which can reduce your tax.

Cons 

• Properties are very illiquid meaning that if you need to realise some capital then you are most likely going to have to sell the entire property or remortgage it.
• Selling property can take some time even if there is a high demand. In periods of low demand it can take years leaving the owner without access to their capital.  Remortgages can also take time and there is no guarantee that one will be granted.
• Tenants have rights and you may not be able to sell your property until their tenancy is finished.
• Property purchase comes with a lot of costs such a solicitors fees and stamp duty. Selling also come with costs and also Capital Gains Tax.
• Rental income is taxable at your marginal rate and could push you into a higher rate tax bracket depending on your other earnings.
• Because of the high costs of properties most people have only one or a very few properties, therefore you are putting “all your eggs in one basket” which increase your investment risk.
• If tenants cannot be found due to market changes or economic situations then you could be faced with no income and mortgage repayments to make a double whammy of losses which can be further exacerbated by falling property prices.
• You are responsible for maintenance which can be costly and there are significant legal requirements for landlords.
• If mortgage rates rise the rental income may no longer cover the costs.

Pros –

• The investment is managed for you by a fund manager so you do not require any experience yourself.
• For collective investments the manager is usually obliged to repurchase your investment at the asset value if you wish to encash so you do not need to find a buyer.
• They are more liquid as you can sell a proportion of the investment should you require capital.  Shares in property companies are slightly less liquid as they do require you to find a buyer, however if they are traded on the stockmarket this is rarely a problem but the value is based on supply and demand rather  than just asset value.
• You will be part of a large portfolio of property investments therefore losses on part of the portfolio are often offset by gains on other parts and vice versa so you tend to get less volatility than direct investment.
• Costs of purchasing and owning properties is shared amongst the fund.
• It is possible to access many of these investments through an ISA therefore the tax efficiency of these becomes greatly enhanced.

Cons –

• You have no direct control over the property investments as you are part of the crowd.
• You have to pay for the expertise of the fund manger and their staff so your profits are reduced by the costs.
• Many funds reserve the right to delay repurchasing your investment by up to 6 months. This allows the fund manager time to sell properties if necessary to meet the demand for investors leaving the fund.
• There may be tax within the fund that is not reclaimable.

Many people look to their pensions to provide the capital to invest in property.  This can be done in several ways and has never been easier with the recent pension freedoms introduced by the government recently.

• Pension funds can invest directly in property using either a Self Invested pension (SIPP) or via Drawdown Funds.  The type of properties are restricted to mainly commercial ones.  Borrowing to make the purchase is also possible but again is restricted in terms of the amounts that can be borrowed.  Professional financial advice needs to be taken as this is a complicated area.
• Indirect property investment can be done far more simply using pension property funds.  These funds are available while you are saving in to your pension and also after retirement when you are using your pension pot to provide a retirement income.  Again it is important to seek financial advice.