Most investors know that property is a key component of any sensible investment portfolio. UK property has been an effective and robust way to store value, generate income and protect against inflation due to long term factors that keep demand high and constrain supply. These include population growth, limited land for building and tight planning regulations. It\u2019s also allied to a robust and well-organised legal system, which has developed over hundreds of years.<\/p>\n
There are many ways to get exposure to this asset class, not all of which have the same risk and return profile. Here, we\u2019re going to weigh up the different types of property investment. You can click through to read more about each type of property investment below.<\/p>\n
Before describing the different ways to get exposure, it\u2019s worth reminding ourselves of the different key ways of funding a property investment, and one of it’s great challenges.<\/p>\n
Broadly speaking, most properties will be purchased with a combination of finance raised as equity and debt (or mortgage).<\/p>\n
Mortgage finance is simply a loan at a specified interest rate, which is repaid either over time, or at the point of the property being sold. It is secured on the property – that\u2019s to say the provider of the debt has the right to take over the property if the interest is not paid. But otherwise the provider of the debt has no right to any increase in value of the property.<\/p>\n
With equity, when you buy an asset your returns are related to the performance of that asset. It carries the right to benefit from any increase in the value of the property – so long as the debt is paid off in full.<\/p>\n
The ratio of debt to equity is called gearing. For example, if a property is purchased for \u00a3100,000 using a \u00a350,000 mortgage, it is said to be geared at 50%. Gearing is important as it magnifies the gains (or losses) on the equity. If the property is sold for \u00a3120,000, the equity portion will be worth \u00a370,000 as the debt is still \u00a350,000. This is a return of \u00a320,000\/\u00a350,000 or 40%. Without the gearing, the return would only be \u00a320,000\/\u00a3100,000 or 20%.<\/p>\n
One of the great challenges of property investing is that it\u2019s an expensive asset class to acquire and trade, and one which requires considerable expertise to identify and avoid pitfalls. This tends to make it very illiquid compared to other asset classes like stocks and shares.<\/p>\n
Why is it so difficult and expensive to trade?<\/p>\n
Well firstly, every property is different, and its value needs to be assessed independently. We\u2019re not dealing with cars coming off a production line here. Property value is related to a wide range of factors including location, condition, tenants, local economy, land history, legal rights etc. Residential property in particular is valued on a supply and demand basis, which means that effective marketing is an important part of achieving theoretical valuations. For commercial or multi unit properties, due diligence and legal costs tend to be significant as the range of potential value destructive issues multiply. For less experienced buyers, the pitfalls can be many.<\/p>\n
Finally, the government levies tax on property transactions called Stamp Duty. This is paid by the purchaser according to the value of the purchase, whether it\u2019s residential or commercial, and whether a residential property is being acquired for owner occupation or as an investment. As general rule of thumb, one can assume that total purchase transaction costs will range from 5%-9% of the purchase cost.<\/p>\n
So, given an understanding of debt, equity, gearing and transaction costs, what are the best ways to get exposure to this asset class?<\/p>\n
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Perhaps the most well-known way to invest in property is buy-to-let: you own a property outright and become a landlord, collecting rent from your tenants. You manage the property to ensure that your yearly takings exceed the cost of owning the property, earning you a profit.<\/p>\n
You can invest in the shares of companies who develop or invest in property themselves, or pool money with other investors via a property investment fund. An advantage of investing in listed companies or funds is that you can generally invest within your SIPP or ISA, therefore deferring or shielding tax.<\/p>\n
Peer to peer property lending offers you the opportunity to lend your money to a property developer and earn interest on the loaned funds. Loans are typically short-term and return a relatively high rate of interest, but can be high-risk.<\/p>\n