How to invest in property

Property investments are back in the spotlight after a tough couple of years amid soaring mortgage rates and increased building costs.

On 1st August, the Bank of England (BoE) took the decision to cut base rate for the first time in four years, from 5.25% to 5%, fuelling the market with optimism at the prospects of lower mortgage rates.

The newly elected Labour government also has a renewed focus on fixing the housing crisis and to get Britain building again, with the aim of delivering 1.5 million homes over the next five years.

It’s not the first time government have made pledges to build more houses. But it has certainly got many experts talking about what could be next for the property sector. How can investors gain exposure to this sector as part of a diversified portfolio?

Types of property investment

1. Direct property investments

• Buy-to-let is the most common way to invest directly into property. This involved purchasing a property with a buy-to-let mortgage, and then renting it out to a single household e.g. a family, a couple, or an individual. As the owner of the property, you can benefit from a regular rental income and the potential for capital growth through rising property prices over the long term.
  
• Houses in multiple occupation (HMOs) is another type of rental property. The concept is essentially the same as buy-to-let. However, HMO properties are occupied by multiple tenants who have their own individual tenancy agreements with the property owner - student accommodation is an example of an HMO property

Which is better? From an investment perspective, HMOs typically yield a better return as each tenant pays individually compared to a single rental income for buy-to-let properties.

That said, HMOs properties require more leg work and have higher initial set-up costs as the properties often have to be fully furnished. Landlords are also required to apply for a license for HMOs, and have to adhere to health and safety legislation for communal spaces, such as kitchens, bathrooms and living rooms.

Like any investment, you’ll need to weigh up the pros and cons with each opportunity and pick the option which offers the best risk/return profile.

Read more: Buy-to-let: what are the alternatives?

• Buying a property abroad continues to be a popular option with us Brits. Both as an investment opportunity through letting to holiday goers and having a place to stay for your own vacations - a home from home. Given an individual’s largest asset is likely to be their main residence, investing in multiple properties in their home country will increase their exposure to the UK domestic market. So, buying a property abroad has its diversification benefits so you aren’t putting all your eggs in one basket. Read more about buying a property abroad

2. Indirect property investments

Investing in property indirectly through funds, shares and other investment vehicles can arguably offer better alternatives to direct property investments. You still benefit from long-term capital growth and income without the additional hassle of dealing with tenants.

Here are the main types of indirect property investments:

• Property shares

One way to gain exposure to the property sector is to buy shares in publicly-listed companies. As the shareholder, you could potentially benefit from any underlying profit the company makes in the form of capital growth (the share price rising) and/or any income the company decides to pay back to its investors through dividends.

For example, you could choose in invest in a company which builds new homes, providing exposure to the residential side of the market. Or, perhaps in a company that buys and rents out commercial properties.

• Real estate investment trusts (REITs)

REITs are companies that invest in property. They own and operate a variety of properties which are looked after by an expert management team. This helps to spread risk and means they don't rely on a small number of properties. They typically specialise in different areas across commercial property such as retail, industrial and office.

REITs are classed as a collective investment, similar to property funds (we’ll come onto these shortly). But one of the key differences is that they trade on a stock exchange with a live market price like individual company shares.

This type of investment is ‘closed-ended’. This means there’s a limited number of shares available to investors and makes it possible for the shares to trade above, or below, the net asset value (NAV) of the underlying assets. For example, if the market value of the shares is worth £100m, but the value of the underlying assets is £50m, the shares would be trading at a ‘premium’ of 100[RM1] %. The opposite is also possible and the shares could trade as a ‘discount’.

REITs can also borrow money to invest (gearing) – this can enhance returns, but can also increase losses, so it’s higher risk.

• Property funds

Mutual funds, like unit trusts (UTs) or open-ended investment companies (OEICs), can also invest in property.

One of the key differences for this type of investment is how the fund is operated. UTs and OEICs are ‘open-ended’, which means the fund manager who managed the portfolio can create or cancel units/shares depending on demand. This can cause a problem when the fund manager invests in physical bricks and mortar and there are significant inflows or outflows from the fund.

In the case of increased inflows, the fund manager would need to find new properties to buy. Find properties in the right places for the right price can be hard to find and it’s a lengthy process. On the other hand, increased outflows mean the fund manager may need to sell some of the properties within the portfolio to raise capital and return it to the investors.

This can be challenging as properties are extremely ‘illiquid’. It can take a long time to turn bricks and mortar into cash. For this reason, it’s not uncommon for property funds to get suspended or gated meaning investors cannot get access to their capital during this time. That is why REITs are often preferred over property funds.

Should I invest in property?

If you’re wondering how to get into property investment, it’s worth noting that investing in physical bricks and mortar for income isn’t as attractive as it once was. Higher interest rates have increased the risk-free rate from safe investments like government bonds and cash, depressing the values of other assets. Tighter regulation and higher taxes have also eaten away at the yield available from rental properties for increased hassle.

All things considered, it could be possible to achieve a better rate of return by investing in property through indirect investments. It’s also possible to hold these types of investments in tax efficient products, like Self Invested Personal Pensions (SIPPs) and Individual Savings Accounts (ISAs). Any investments held in these types of accounts won’t be subject to income tax or capital gains tax (CGT). You can also get tax relief on the contributions made into a SIPP.

Saving on tax where possible is more important than ever as the new Chancellor, Rachel Reeves, recently announced that “we’ll have to increase taxes” to reclaim the £22bn “hole” left by the previous government. She reiterated she would not raise VAT, national insurance, or income tax, so increases to CGT could be on the table.

Read more: Chancellor’s speech signals Labour’s tax direction

As always, it’s important for investors to stay diversified across a range of assets classes, including shares, bonds and alternatives like properties and commodities. Any investment decisions you make should be aligned with your long-term investment goals and risk appetite.

Investment opportunities

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