As an asset class, it has performed well over the long-term and remains relatively straightforward to understand.
Property investors make money from rental income and, hopefully, an increase in the value of property over time. This combination creates the foundations for a compelling investment option.
But the UK property investment market is changing.
Will the investment models that have worked in the past continue to work in the future?
Download your FREE guide and find out more about the benefits, risks and potential returns associated with investing in UK residential and commercial property.
As with other investment opportunities, property can adapt to individuals’ financial objectives, such as delivering investment returns in the form of growth or income (or both in fact). The increased number of products available also allows investors to assemble a portfolio of investments that, in combination, match their preferred risk profile.
There are also a range of investment structures that can be managed either actively or passively. In property terms, these are typically referred to as directly or indirectly managed investments. It has long been possible to invest in property by, for example, buying a house and renting it out (Buy To Let, a direct investment). Equally, making an equity investment in a property fund is an established indirect investment.
In broad terms, there are three core investment opportunities when it comes to property: residential, commercial, and land. Importantly, each have a number of opportunities within them, all of which have different characteristics and risk-return profiles. More recently, the various different ways of investing in land has seen this join residential and commercial as a property investment option.
Technology-led investment platforms enable investors to access a more varied property investment marketplace than ever before. You are no longer restricted to one or two options; you can assemble a diverse property investment portfolio relatively quickly and in a particularly cost-effective way.
Some of the more innovative investment products represent higher risk / higher return profiles and provide investors with greater scope to tailor investments to their specific preferences.
As with all investments, property investing can be heavily influenced by global events and trends. However, the enduring appeal of property as an asset class is that it will always be needed; people will always need homes to live in and businesses will always need premises to operate.
Residential property and commercial property investments have some similarities, but there are also some fundamental differences.
The demand for residential rental property continues to increase. The UK doesn't build enough homes which affect affordability and drives the need for rental properties.
In a recession, the demand for residential rental property increases, particularly if would be homeowners struggle to access mortgages. Conversely, commercial property is generally adversely affected if the UK economy falters but can bounce back quickly when the economy improves.
A balanced property investment portfolio can include both residential and commercial property precisely because economic drivers impact demand and value in different ways.
Perhaps the most recognisable of all property investments, buy-to-let properties are generally owned by individual landlords and are purchased on the basis of renting them to tenants. Returns from buy-to-let can be realised in the form of rental yield (income exceeding any related costs) and/or capital growth (an increase in the value of the property when it comes to being sold).
Rental yield and capital growth combine to produce the total return that a buy-to-let investment offers. Importantly, while rental yield was, for many years, considered the principal rationale for making buy-to-let investments, recent legislative changes in the treatment of this has reduced the rental yield potential for many. While buy-to-let investments exhibit a similar risk profile to many other property investment opportunities, they do retain some differences.
These include the need to keep the property in a good condition (including making repairs promptly), the management of tenants (although this can be outsourced, problem tenants can still create a headache for landlords), and rental voids (periods without tenants, whereby you not only have to cover the mortgage payments but the council tax, too).
This investment option is essentially a subset of the buy-to-let model with an exclusive focus on achieving rental yield through letting to students. The student rental sector has been the best performing asset class in the UK since 2011, with high yields and low void rates helping to attract investment in excess of £3 billion into student property in 2016.
Investors in this market have historically focused on maximising rental yield by reconfiguring established residential properties for students. However, recent legislation has sought to restrict this practice (see the subsequent section for details). This change in legislation has coincided with increased demand for purpose-built student accommodation, which is itself becoming a more popular investment option. Although the returns through this can be less than the more traditional route (as such investments are usually managed via a third party), it can nonetheless be an attractive proposition for passive investors.
The increase in the student population drove demand for private rented, residential accommodation. While this often proved to be a lucrative investment, particularly in terms of rental yield (which can be up to three times higher than a traditional buy-to-let rental), it also attracted criticism for disrupting established communities.
This led, in April 2010, to the introduction of a House of Multiple Occupation (HMO) use class for properties inhabited by three or more unrelated people who share bathroom and kitchen facilities. Many local authorities now contain zones where allocating a property as an HMO requires planning consent. And while the benefits are clear (the premium rental yield, for example), these are accompanied by additional risks. One of the most notable is that selling the property can prove to be more difficult; having been an HMO, it will often require extensive renovation to return it to a ‘standard’ property.
Since 2005, the UK Government has actively encouraged institutional investors to extend the provision of private rental properties through investing in Private Rental Sector ("PRS") developments.
Measures that have sought to encourage this include Real Estate Investment Trusts ("REITs"), the amendment of Stamp Duty Land Tax ("SDLT") in 2009, which led portfolio buyers to pay the same SDLT as buy-to-let investors acquiring a single unit, and in 2013, the creation of a PRS Taskforce to establish which incentives would most effectively stimulate further growth.
The process of investing into property off plan is as the name suggests; you commit to purchasing a property before it has been built, basing your decisions on an assessment of the market and the specification provided by the housebuilder. Such investments can be made one or two years before the property is ready to live in. Through this approach, you are required to provide a deposit and pay a reservation fee when you commit to purchase. The balance will be due when the property is ready to live in. As an investment opportunity, buying off-plan relies on two fundamental appeals.
1. If you buy off plan, you can often secure a discount from the builder.
2. If the property increases in value in the time between you reserving it and it completing (and you then sell the property), this increase in value can be expressed as a proportion of your deposit, rather than the sale price.
Although this creates an attractive proposition, the associated risks are similar to anything purchased in advance of completion. These relate to there being some unknowns - with the property unbuilt, establishing market demand can be tricky, and the value of the property can go down as well as up.
Making a series of off-plan purchases might be possible because they can be secured with relatively small deposits. However, doing so creates a significant financial liability that could be problematic if the properties proved difficult to sell.
Investing in properties that require refurbishment requires foresight and, often, a medium-term to long-term investment outlook. This form of investment represents an opportunity to achieve either rental yield or capital growth (or both). Whichever return is sought, this will require (potentially extensive) work to bring the property to a condition that it can be sold/rented, ideally to a standard that will realise its full market value.
Investing in properties for refurbishment offers clear incentives; buying a property at a reduced price can even taking account of the cost of renovation, deliver alluring net returns. However, risks also accompany this: what if the renovations run over budget, where will additional finance be sourced from? What if the market turns and the property fails to realise the required sale or rental value? If the renovation period exceeds its deadline, is it possible to extend the terms of the capital borrowed to purchase the property?
Unlike residential property investments, where returns can be achieved in a variety of economic scenarios, returns on commercial property are closely tied to economic prosperity.
The market for commercial property is generally a good barometer of business and investor confidence. This assessment provokes a level of caution amongst investors and for individual investors can be decisive in dissuading investment.
The different sub-classes of commercial property operate in a relatively consistent way. The more significant decision as an investor is not whether to invest in office, industrial or retail units, but whether to invest directly or indirectly. As with residential property investment, there are no right or wrong answers, and the decisions made should be based entirely on your personal investment preferences.
Office space is graded based on its location and specification. The grading system runs from ‘A’ through ‘C’.
‘A’ grade accommodation is the most desirable; to achieve this classification it must combine premium location (e.g. in a central urban location) and high specification (e.g. climate controlled, superfast broadband).
Office accommodation that offers one but not the other is typically classified as ‘B’ grade, and commercial accommodation offering neither is generally classified as a ‘C’ grade property.
Industrial property units tend to be much larger and located in sparser, less urban environments, often with good access to transport
Industrial units are most commonly populated by logistics and manufacturing businesses, reflecting the characteristics needed by these sectors.
Opportunities to invest in retail property development are as diverse as the retail sector itself; from a small, suburban, single unit tenanted by an established newsagent to a purpose built mall with a range of pre-lets to household names requiring associated infrastructure works.
As with all asset classes,
Property investment opportunities are presented as one of four classifications: core, core plus,
Experienced investors often seek to balance risk across their investment portfolio; they may choose to invest in core property investments and complement these with riskier investments in early-stage businesses, for example.
An investor seeking to balance risk while investing exclusively in property could nonetheless achieve diversity by assembling a portfolio that included investments across the four different classifications.
No investment is entirely free of risk. Even financial products that protect your capital represent a risk in the sense that they offer low returns that could result in your capital losing value in real terms.
Property investments all contain an element of risk, but on the risk spectrum, core property investments represent the least risky. Investing in core properties means investing in properties that offer solid rental or resale potential. While this can not be guaranteed, these properties are part of a market where demand is consistently high. This high demand is also likely to be driven by many different sources so that a decline in one can be overcome.
Core investments hold up well in the majority of financial scenarios (and are only negatively impacted by the most dramatic of financial downturns). A prime example of core retail property is Oxford Street in London; rental voids are very rare on the UK’s busiest high street. However, as with all ‘safer’ investing options, there is a trade-off on the potential return. Core property investments are often more expensive, and this makes the yield lower, as a proportion of the cost.
Similar in style to the core classification, the primary difference exhibited by properties that fall into the core plus classification is that they are generally in less prestigious locations.
Examples include retail stores located outside city centres (perhaps in residential areas). Premises accommodated by businesses that offer products/services for which demand is more volatile may also be classified as core plus. For example, premises used by companies operating self-storage facilities: although this service is needed, it is not a necessity and therefore has a higher risk associated with it.
Demand for this service is influenced by numerous factors beyond the business operator’s control. Given this mildly increased level of risk, investors into core plus classified properties should, therefore, anticipate a rate of return that is subject to greater variation. This variation in the rate of return could come in either direction, increased or decreased.
As its name suggests, properties that fall into the value-add classification are those that currently command below average market value.
The market value of these properties can be increased following some level of refurbishment to bring them to a level whereby they can command a market value comparable to similar local properties.
The type of properties within this classification vary greatly, from a retail outlet that requires minor refurbishment before it can be let right through to a dilapidated warehouse that needs wholesale structural repair before it can be sold.
Clearly, the potential to achieve growth in the value of investments made in this classification is considerable, but so is the investment required above and beyond the purchase price. Similarly, the work needed will take time to carry out, which could add on several months to the time with which the property is held (and the capital borrowed to purchase the property serviced) before the return can be realised.
An opportunistic investment style usually relies on the cyclical nature of the property market. For example, in an economic downturn, commercial property prices call fall due to lack of capital and demand from businesses looking to rent offices, warehouses and retail premises.
In some cases, the commercial property owners are under pressure to lease the properties but can't find tenants to occupy. If there's a loan against the property, then the lender may put pressure on the building owner to sell in order for the loan to be repaid. In more extreme circumstances, the lender may repossess the property and offer it for sale at a discounted price.
An opportunistic investor will look for these below market value properties where there's an opportunity to purchase at a significant discount.
If you would like your property investment to deliver income, you should be more interested in the yield that your investment offers. This is the financial return that you would expect to receive on a regular basis. Rental yield is a term associated with monthly rental payments that you would receive should you invest in a residential buy-to-let property. Dividend yield is the term used to identify regular payments paid by investments across a range of different asset classes.
Growth can be achieved through a range of asset classes. In the case of a buy-to-let property, growth would be realised if you were to purchase a property for £100,000 and then sell it for £120,000 - this would represent growth of £20,000. Equally, if you were to make a £10,000 investment in a property fund and subsequently sell your investment for £12,500, this would represent growth of £2,500.
Having established some of the fundamental considerations that any aspiring property investor should familiarise themselves with, there exists an equally broad range of investment structures with which investors can interact.
Some of these structures offer the opportunity to invest across a range of different investment styles; others are restricted to (or at least closely associated with) specific investment styles. Listed below are a variety of investment structures, followed by a brief description of how they operate.
Direct purchase is the easiest investment structure to engage with; the process of identifying a property and purchasing it alone, funded either by existing or borrowed capital. This model translates across both residential and commercial property, although the direct purchase of residential property is often more achievable than direct purchase of commercial property.
The approach is best described as follows: you raise the money (whether that is through your own funds or borrowing), purchase the property, and subsequently take action to execute your strategy (i.e. utilise, rent or sell).
Importantly, while new property investors may identify with this approach most readily, it is arguably the riskiest investment structure and the one that requires both the most capital and time to be invested. Direct purchase leaves the investor fully invested in the property in every sense; while the returns are therefore all yours, so is the associated risk.
Professional PRS funds
Should an investor seek an income return from a passive rental property investment (and generally have no preference over property type or location), investing in a managed PRS fund may be an ideal solution.In essence, a PRS fund is a collection of investments from individuals, managed by a specific individual, who takes responsibility for the performance of the fund.
The fund manager researches the market and available investment opportunities, encompassing existing PRS buildings, buildings suitable for conversion to PRS, and sites suitable for constructing PRS accommodation. The fund manager will invest with a focus on achieving stable rental income and depending on the performance of the fund; investors will receive a dividend yield.
While the individuals invested into the fund will generally see a lower return on their investment than if they purchased and let the properties themselves, it can be an ideal option for investors who wish to be entirely passive; you invest and take a return, with little to no direct involvement.
Professional residential development
Many property investors begin with residential buy-to-let as their first method of building a property investment portfolio. In many cases, this involves refurbing a property and adding some value before renting the property out.
More experienced property professionals with an element of property development and refurbishment experience choose to expand into residential property development.
Housing demand in the UK continues to increase and most new homes being built by volume housebuilders, there's a gap in the market for smaller residential developer's to develop smaller sites from single plots to larger schemes that generally are too small for larger housebuilders to consider.
Tackling a residential development requires skill knowledge and a decent amount of capital to buy the land and, generally, the ability to raise development finance to build out the residential development scheme. In a sensible economic climate, there are decent profits to be made from developing residential sites. Residential developer's target development profits in excess of 20%.
If you have the skill and experience, then residential property development deliver a lucrative return on your capital employed depending on how you finance a scheme.
Ways to invest in Commercial Property
There are a number of ways to invest in commercial property;
1. Direct Purchase: This is where an investor would purchase an office, warehouse or retail property and lease it to an occupier in return for rental income, and (hopefully) future capital growth.
2. Direct commercial property funds: these are specialist funds managed by professional fund managers. Generally accepted as a common way to invest in commercial property. Investments are made via specialist investment structures know as collective investment schemes. They include unit trusts, OEICs or investment trusts. The fund manager then invests directly into a portfolio of commercial properties, such as supermarkets, offices and warehouses, which are otherwise inaccessible to smaller investors.
3. Indirect property funds: there are many property companies listed on the London Stock Exchange ("LSE"). Examples include British Land, Land Securities, Town Centre Securities etc. Indirect property funds are also specialist funds managed by professional fund managers. However, rather than invest in property directly and take on the responsibility of managing the property, indirect funds buy shares in listed property companies and gain exposure to the market indirectly. The fund's performance is based on the share price of the property companies that make up the overall investment portfolio.
Property company investments
Generally seen as the middle ground between directly buying a property and investing in commercial property funds, investing in property companies gives investors the ability to play a more active role in their investment portfolio. For instance, a commercial property fund that purchases shares may invest partly in British Land, Land Securities and other property companies listed on the London Stock Exchange.
Therefore, investing in such a fund will include an investment in a property company. However, investors can invest directly in a chosen property company, such as British Land or Land Securities. As such, you can make your decision based on your preferences and research. If you invest in these companies directly, you will avoid paying fees to a professional fund manager. Conversely, you will not be able to rely on their skill, experience and focus to manage risk and hopefully improve any potential returns.
Buy-to-let is a good example of a property investment that seeks primarily to deliver an income return, in the form of rental yield. The treatment of rental income and the tax relief available on interest payments impact directly on the net rental yield.
Stella sold 4 The Firs in April 2015. She achieved a total net yield of 30.2% over six years; an average net yield of 5.0% per year. Figure 3 shows that this yield comfortably exceeds the Bank of England base rate, to which deposit account interest rates are pinned. It also exceeds both the Consumer Price Index (CPI) and the Retail Price Index (RPI). Based solely on net income, the investment has increased in value in real terms over the six-year period.
When Stella sold 4 The Firs in April 2015, she achieved a sale price of £142,000; £7,000 more than she paid for it in April 2009. As with the income she received when the property was let, selling the property incurs costs. Stella pays an estate agent 1% of the sale price, a solicitor £750 to cover conveyance costs, and because 4 The Firs is not her main residence, the increase in value is also liable for capital gains tax.
Investing into a special purpose vehicle (SPV) through a crowdfunding platform is a good example of a property investment that seeks primarily to deliver a growth return, in the form of increased value of the shareholding in the SPV. The treatment of capital growth and how to structure investments to maximise tax relief is an important consideration. Your free guide to integrating property investments into your portfolio contains a worked example of the returns available through a crowdfunding investment
The Terminus encountered some delays during the construction phase. Nonetheless, the final apartment was sold in May 2012, and the development was completed in July 2012. The total revenue generated through sales was £21.2 million and, once construction and management/administration costs had been accounted for, the special purpose vehicle was left with £14.99 million to distribute to investors. This was allocated and repaid in September 2012. Caroline received £27,750 through this process, representing a 1.85x return on her initial investment, across 42 months. The Terminus fell slightly short of its anticipated financial return (1.9x) and completed six months behind schedule.
When Caroline received her investment return, its increase in value (£12,750) was liable for capital gains tax. The personal capital gains tax-free allowance of £10,600 in the 2012/13 left Caroline with a taxable gain of £2,150. This taxable gain incurred capital gains tax at 18%, as Caroline was a standard rate taxpayer, resulting in a capital gains tax bill of £387. Allowing for Caroline’s investment initiation fee of £375 and her capital gains tax bill of £387, her net gain was £11,988. This represents a net 1.80x return on her initial investment. This comfortably outperforms the inflation indices (RPI and CPI) and the Bank of England’s base rate (Figure 6). Figure 6 also demonstrates that the investment offers no return during the first two financial years, with the full return received in the third year. Caroline’s investment in The Terminus generates an IRR of 18.3%. Despite achieving a return that exceeded that of Meadow View, the IRR offered by The Terminus is inferior; this is because the development took longer to complete. From a capital gains tax perspective, Martin and Caroline’s decision to make one investment each was immaterial. This is because the two investments matured in different financial years: Martin’s in Meadow View in 2011/12 and Caroline’s in The Terminus in 2012/13. Had one of them made both investments, they could have used their personal capital gains tax-free allowances in each respective year. Had the two investments matured in the same financial year, holding one investment each would have been materially beneficial to their outturn
Property is an asset class into which you can invest through a variety of investment structures. Whilst different investment structures offer different risk profiles, it’s important to remember your capital will be at risk whichever investment product you select.
If you invest directly, you will typically be involved in the management of a property. If you have borrowed to fund your investment, then an increase in the cost of borrowing represents a risk. Even if borrowing represents a small proportion of the capital requirement, you are still exposed to a range of other risks: think rental voids, maintenance costs, or refurbishments taking longer or costing more than forecast.
If you invest in property indirectly through a property bond or peer-to-peer lending platform, you will have a repayment schedule that sets out how your capital and interest will be repaid. However, there is no guarantee that your capital will be repaid on time, or at all. Conversely, if you invest in property indirectly through a property fund or property crowdfunding platform, you will hold this equity investment until you decide to sell it. The value of your investment may decrease (or increase) during this time. In addition, when you do come to sell your investment, you may find that some investments struggle to attract a buyer