Investment in property can take several forms:
Like any asset class, it is important to be aware of the upside and the downside and not have an over concentration in one asset class.
The best known and most practised form of property investment is buying the house you live in. Whilst some may argue your house should be seen more as somewhere to live and not an investment, as a home-owner your finances are linked to the value of your house.
It would appear that the days are long gone where you earned more in a year from the increase in the value of your house than you did from your job. With property prices generally stagnating, your home is more than ever just that – some where you live, and not the road to vastly increased wealth.
Of course, that is not to say that you shouldn’t choose carefully the home you buy. If you are buying now and expect to move again in a few years, you should have at least one eye on its investment potential. Do not indulge in too many improvements that don’t have a similar increase in the likely sale price of your house.
But if you are buying to live there for the foreseeable future, you should be choosing a home you like the idea of living in and be happy to upgrade the kitchen/bathroom because it makes it more enjoyable to live there, even if the impact on the value of your home is more muted.
Buy-to-let is where you buy a house, but someone else lives in it, who pays you rent.
The number of private landlords is still increasing in the UK. But the money needed as a deposit has increased (often at least 25% and around 40% of the price of the property to get the best buy-to-let mortgage deals). Also, the number of lenders willing to offer you a buy-to-let mortgage has fallen, so the interest rates on offer are nowhere near as attractive as those on offer to buy your own home. Add in large arrangement fees and the returns from buy-to-let may be lower than you expect.
Even if you have the deposit needed and find a reasonable deal, there are many other things that will impact on your potential return. Repair and maintenance costs, insurance, periods when your property has no paying tenants (known as voids) and management fees all reduce your overall return.
Whilst we are not saying buy-to-let is a bad idea, you need fully to be aware of the costs that will eat into your return. There are still reasonable returns to be had, provided you pick the right property in terms of cost vs likely rent, the right mortgage (if you need finance) and the right area to minimise voids and maximise rental income. Across the UK the yield after costs can vary, but 5% per year is typical.
So buy-to-let can produce a steady income, and certainly more than you can get on savings alone, but it comes with some strings – it will need a large chunk of money, you need to be prepared to tie your money up, and accept the hassle that comes as a landlord (or be willing to pay a managing agent to do this for you) which will eat into your return.
Got a buy-to-let lined up? Try our modeller that calculates the likely return after taking into account some or all of the above issues. If you don’t know what some of the things might cost, we have provided some average costs to help you. Click here to try it out.
Also, there is loads of reading on the internet – try here for instance.
If you like the idea of buy-to-let, but are put off by the likely hassle, the issues above, or simply because you do not have the sort of money needed for a deposit, you can still get exposure to buy-to-let using a REIT (pronounced “Reet”). REITs are listed on the stock market and pay regular dividends (assuming they remain profitable). Like any listed investment, it does mean it is easier to invest and then sell should you need to.
REITs were created in 2007 and have tax advantages such that many sizeable landlords throughout the UK converted to REIT status. Some well-known FTSE 100 property companies are in fact REITS.
Note however, that REITS do not invest solely in residential property – many will own offices, shops and industrial sites. You need to do your homework and check what each listed REIT actually owns to make sure you are investing in the property sector and geographical location you are interested in.
There are some differences between the way dividends
If you fancy getting property exposure via owning shares in a REIT you should do some more research. A useful starting point is the REITA website, part of the British Property Foundation.
Like any asset, the price of property can go up and down, and there may be bubbles or periods where prices become over inflated and then suffer a drop to return them to a more long term average.
Many commentators believe property around the world (including the UK) remains over-priced due to the over-supply of cheap credit that led to the credit crunch still not having fully worked through the system. Whilst in some countries house prices have dropped back towards long term trends, some countries appear to remain in bubble territory. See Economist index here for one view.
And try here (again the Economist) to see how these trends have behaved over last 30 years including useful ratios such as prices to average earnings and prices to average rental values.
If you own a property and all you need is the annual income and not the capital sum invested, then you may not be too concerned if property values fluctuate. This is assuming the rent remains reasonable compared with the original buying costs of the property. If prices do fall, then the rental value may also fall, but assuming the property remains let, you will still be getting an income, albeit it may be lower than you hoped for.