Four ways to invest in property
Over the past few decades, returns on property in the UK have been impressive. Despite a couple of blips, the residential sector has done particularly well and anyone who still owns a home they bought in the 1990s, say, is likely to be sitting on significant gains.
But for anyone who wants to invest directly in bricks and mortar, the process can be far from straightforward.
Becoming a landlord and renting out a house or flat is the most common option but this requires a large amount of capital - to put down a deposit on a buy-to-let mortgage or to buy the property outright - as well as significant ongoing costs for maintenance and dealing with tenants.
However, it is possible to get exposure to gains from the property sector in a much simpler manner via the stockmarket. Investing in the shares of companies that construct houses and other buildings, for example, can act as a proxy for owning property.
There are also a large number of funds that pool investors' cash to buy commercial property such as office buildings, warehouses and shopping centres.
It is now even possible to buy small shares of individual homes through crowdfunding services, as we explain on page 15. So what are your options if you want to invest in property?
Commercial property funds
Collective investments that pool money to buy property that is rented out to businesses are perhaps the most common way for individuals to invest in bricks and mortar – indeed, these are often called bricks-and-mortar funds.
Victoria Hasler, head of research at analyst Square Mile, says that there are a number of reasons people might consider investing in commercial property, namely income generation, capital growth, diversification and as a hedge against inflation.
"I suspect that at present most investors are largely concerned with the first of these potential reasons," she says. "With bond yields still at very low levels, cash rates at, or close to, zero, and many higher-yielding stocks looking rather expensive, the income generated by investing in property has been a useful boost for many investors."
Hasler adds that commercial property funds have enjoyed renewed popularity over the past few years, thanks to these yields and the diversification benefits they offer.
There has also been increased interest from overseas, she says. "Foreign buyers have become an increasingly important presence, and sovereign wealth funds in particular now have more and more influence, especially in London.
"This has heightened pricing pressure in the market and presents something of a problem for the more valuation-sensitive fund managers, as many sovereign wealth players are prepared to pay a premium for prime London locations."
Patrick Connolly, a certified financial planner at independent financial adviser Chase de Vere, says his firm typically holds between 5% and 15% of client portfolios in commercial property.
"It can provide consistent long- term returns and its diversifying nature provides some protection from stockmarket falls," he says. Chase de Vere currently recommends Henderson UK Property, L&G UK Property and M&G Property Portfolio.
But there are challenges facing investors. "There is relatively little value left in the best-quality prime properties, which have been in great demand, pushing up prices," Connolly adds. "We are seeing fund managers moving more of their portfolios into secondary properties, where prices are much cheaper but also where the risks could be greater."
The large inflows of money into these funds over recent years have created further problems, Connolly says. "Some funds are now sitting on quite high levels of cash and, with lots of money chasing property investments, it becomes even more difficult for managers to find real value.
"Also, we've seen in the past the potential liquidity problems that can arise if too much investment money floods into commercial property."
Hasler agrees that liquidity can be a serious problem. This means that many investors at times may find it difficult to cash in their holdings: fund managers are entitled to block outflows if they feel it is necessary, as happened following the financial crisis in 2008.
"Liquidity in the commercial property market is lumpy at the best of times and tends to become markedly worse at times of stress," she says."As the market falls, many investors want to get out and they or their fund managers are forced to sell properties into a falling market, thus pushing prices down further.
"The fundamental problem here is that the property market relies on anyone who wants to sell a property finding someone else who wants to buy it: when everyone thinks the market is going down, then all the trades are in one direction."
Real estate investment trusts (REITs) are another way of investing in commercial, and sometimes residential, property.
Like a bricks-and-mortar fund, a REIT holds a portfolio of property but it is structured as a discrete company and traded on the stockmarket as such.
Hasler says that REITs have some advantages."As these are listed equities, they remove the liquidity issues of direct property investments," she explains. REIT holdings can be sold at any time – albeit not at a price the investor may like.
"The downside of investing in REITs is that they tend to be fairly highly correlated to equity markets, particularly over the short to medium term: this removes some of the diversification benefits of investing in commercial property."
Shares in property companies
Buying shares in property-related businesses, such as housebuilders Persimmon and Taylor Wimpey, is another indirect way of benefiting from rises in property values. But like REITs, these shares will move to some degree in line with equity markets.
Connolly says: "The results of the General Election were perceived to be positive for the housing market and for housebuilders and related shares in general, as the threat of Labour's proposed mansion tax seems to have passed.
"These shares have performed incredibly well, to the extent that they might now be looking pretty expensive."
But he warns of the more general dangers of investing in individual companies. "Investing in individual shares is high risk. It wasn't too long ago that high street banks were considered to be safe and secure stocks and were held by many investors looking for steady capital growth and a reliable dividend income."
A better approach, Connolly says, is to buy investment funds that hold property- related shares as part of a wider portfolio. "Managers have the flexibility to invest in these areas if they see opportunities but avoid them if they see greater risks and a lack of value."
For investors who want greater exposure to residential house prices, Castle Trust's Housa investment pays returns based on the performance of the Halifax house price index.
Connolly adds that there are some funds that allow investors to access actual residential properties. "Hearthstone Investments has an eligible residential property fund investing in a portfolio of buy-to-let properties."
Hasler says: "Default rates on residential buy to let have actually been remarkably low in recent history but this may not continue for ever. And it will be interesting to see how this market develops with the changes in pension regulations."
She has a final, more general, word of warning for those considering adding property to their investment portfolios.
"It's easy to forget that most retail investors already have a large investment in property - usually the dominant part of their wealth - in the form of the house they live in," she says.
"While this is residential property, and in many ways different from commercial property, it is worth bearing in mind as it may lessen the diversification benefits to an investor's overall wealth."
A catch-all phrase that can range from assessing the price of a property or vehicle before offering it for sale or the net worth of assets in an investment portfolio to the prices of shares on a stock exchange.
An increase in the general level of prices that persists over a period of time. The inflation rate is a measure of the average change over a period, usually 12 months. If inflation is up 4%, this means the price of products and services is 4% higher than a year earlier, requiring we spend and extra 4% to buy the same things we bought 12 months ago and that any savings and investments must generate 4% (after any taxes) to keep pace with inflation. Since 2003, the Bank of England has used the consumer prices index (CPI) as its official measure of inflation (see also retail prices index).
An interchangeable term for shares (UK) or stocks (US). Holders of equity shares in a company are entitled to the earnings and assets of a company after all the prior charges and demands on the company’s capital (chiefly its debts and liabilities) have been settled. To have equity in any asset is to own a piece of it, so holders of shares in a company effectively own a piece proportionate to the number of shares they hold. (See also Shares).
If you own shares in a company, you’re entitled to a slice of the profits and these are paid as dividends on top of any capital growth in the shares’ value. The amount of the dividend is down to the board of directors (who can decide not to pay a dividend and reinvest any profits in the company) and they will be paid twice yearly (announced at the AGM and six months later as an interim). Dividends are always declared as a sum of money rather than a percentage of the share’s price. Although dividends automatically receive a 10% tax credit from HM Revenue & Customs (HMRC), which takes the company having already paid corporation tax on its profits into account. Dividends are classed as income and, as such, are liable for personal taxation and so shareholders have to declare them to HMRC.
The catch-all term applied to investors who buy properties with the sole intention of letting them to tenants rather than living in them themselves, with the proceeds from the let usually used for the repayment of the mortgage. Buy-to-let investors have to take out specialised mortgages that carry higher interest rates and require a much bigger deposit than a standard mortgage. Other expenditure can include legal fees, income tax (on the rental profits you make), capital gains tax (if you sell the property) and “void” periods when the property is unlet.
Everything you own: all your assets (property, cars, investments, savings, insurance payouts, artwork, furniture etc) minus any liabilities (debts, current bills, payments still owed on assets like cars and houses, credit card balances and other outstanding loans). When you’re alive this is called your wealth; when you’re dead, it becomes your estate.