Property as an Investment
Property has always been a major investment sector, particularly for the large-scale institutional investors such as the pension funds and insurance companies.
But for the small investor, (apart from owning your own home) property has for long been overshadowed by the various investments opportunities provided by banks, building societies, pensions, investment and unit trusts, and stocks and shares.
People have always appreciated the benefits of owning property (bricks and mortar) over the long-term, particularly regarding capital appreciation. and some small private landlords have stuck with property investments through “thick & thin”, through good times and bad.
Markets are Cyclical – prices go up and down
Investment markets of all kinds are cyclical in nature (they rise and fall over time) but investment in property (particularly residential) was hampered for many years through legislation which was clearly biased against the investor/landlord.
More recently the UK investment scene has changed quite a bit, so much so that property has once again come into favour as an investment medium, particularly for the small investor, but this time on a scale as never seen before.
Factors Favouring Property – long term:
Low inflation and interest rates – mean that it’s hard to find decent returns on cash investments such as bank and building society accounts.
Volatility in the stock markets – has led investors to think twice about putting more money here – over recent years market returns have been good, but currently the stock market looks decidedly risky.
Problems with pensions – with the demise of stalwarts like Equitable Life and diminishing returns on annuities (UK rules mean that most of your pension return comes from the purchase of an annuity) people are thinking that pensions are not the only place for your money, even with their tax incentives.
House price inflation – we have seen some quite dramatic rises in property prices over recent times. However, prices can fall back as we are witnessing in 2008.
Increasing job mobility – more single households and rising property prices have been a boost to the demand for rented accommodation.
A re balancing of the housing laws (1988 and 1966 Housing Acts) – now make it much less risky to let residential property. So much so that the average man in the street is happy to become a landlord.
Increasing affluence – in the UK (recessions excepted) means that there are now many more people with second homes and funds available for investment.
The Buy-to-Let mortgage – has brought down the cost of borrowing funds for residential investments – so much so that the success of the buy-to-let mortgage has led recently to the comment that we are becoming a nation of landlords!
Investment Returns – back to basics
Different types of investment can be compared both in terms of their overall risk, and their potential rewards (yield).
Investments give you two kinds of reward: interest (income) and capital growth (increase in value).
The safest forms of investment may only give one of these, for example, a National Savings Bank investment will give you a guaranteed interest of about (3% 2002) with absolutely minimal risk – you are guaranteed to get your capital back, but the capital will not appreciate in value.
At the other extreme, a high performance share in a smaller company may give a low income (dividend payouts minimal) but a high capital appreciation (growth in share price)
This is obviously a more risky investment because you could lose some or all of your capital if the company goes wrong, but you could also make a lot if the share prices multiplies 10 fold in 12 months.
These two examples are at two extremes of the risk spectrum:
Low risk ________________________________High risk
Inflation & Taxation
With any investment you should take inflation and taxation into account. The National Savings investment may return little better than the current rate of inflation, giving a real rate of return over time approaching zero!
On the other hand, the high risk share investment, if it works out, may return many times the rate of inflation.
With these two types of investment we also have two extremes with regard to taxation: the former is tax free, whereas the latter will be subject to both Income Tax (on the dividends paid out annually) and to Capital Gains Tax (on the increase in capital value over time).
Lets suppose we buy a mixed property investment for £100,000 – a retail shop with a flat above in a good area – one with a highly dense population and lots of surrounding amenities and transport links.
The property is a bit run-down so you spend £10,000 on refurbishment and manage to let fairly quickly to two good tenants.
Where on the scale of investment risk does our property investment lie, and what are the inflation and taxation factors we need to consider? In what other ways does our property investment differ from the others?
Well, as an individual investment it’s difficult to quantify risk as so many factor enter the equation, but on average a property of this type should be quite a bit more risky than the National Savings investment but much less risky than the high flying high risk company shares.
Property inflation has been high recently compared to the general levels of inflation (RPI), therefore the value of the property, on past experience, should be expected to rise well above the inflation rate. Commercial properties have tended to rise less spectacularly than residential so expect only a steady increase here.
Taxation on property investments is similar to that imposed on businesses and certain expenses can be claimed – see Taxation
Why is property investment different?
Income is generally high in relation to the capital values – for example the above property (in a good area with good tenants) may easily return a rental of ?8,000 for the shop and ?5,500 for the flat – a return of 12.27%
Given the property inflation we have been experiencing the capital value of the investment, given it now has good tenants and is in good repair, could well increase to ?145,000 after the first year.
This would give a total return of 13,500+35,000, or 44.1% return. Sounds too good to be true?
Well, if all these factors fall into place, it’s perfectly possible.
Your property investment is going to need active management. This can be done either by yourself or by letting/managing agents.
It’s very unlikely that you could lose all of your investment as you can with shares. Unless you forget to insure it and it burns down to the ground – your money is relatively safe.
But remember, unlike shares and savings there is no quick way to get your money out. Investors in properties like this don’t come along every day, so you may have to wait some time if you need the money back.
You can of course borrow against the property if you need to.
Warning: Investments in property can go down as well as up in value and property can sometimes take a long time to dispose of. Never invest money in property which you may need in the short-term – invest with a long-term perspective.