Heads up: this Pack is aimed at Finimizers in the UK. Click here if you'd like to dive into US real estate.
As well as your common or garden stocks and bonds, a balanced investment portfolio may well include “alternative investments”. These often higher-risk (but potentially higher-reward) investments include hedge funds, crowdfunding, art, cryptocurrencies, private equity, and venture capital.
But one group of alternative investments that has both a real-world utility and, compared to others, comparatively low risk, is real estate – or property.
Property investments tend to be considered more “slow and stable” because apartments and office blocks aren’t directly traded on an exchange (even if big property-owning companies can be). This helps insulate real estate from daily swings in value. UK commercial real estate (i.e. offices and shops) saw total returns of 6% in 2018 and UK residential real estate (i.e. houses and apartments) returned around 3% – although there were regional variations, naturally.
If you’ve got a big mountain of cash lying around, you might buy a property outright. Less Alpine cash piles might make up the typically sizable deposit with which you can get a mortgage – a long-term loan secured against the real estate you want to buy. But more on this later.
As the owner of a property, you stand to benefit from any rise in its value when it comes to selling, from the income it can generate if you rent to tenants – and, of course, from the utility you get from living in or using it yourself.
Interestingly, the attractiveness of outright property ownership is partly dependent on culture. In the UK, for example, property ownership is fetishized: “an Englishman’s home is his castle”. But in countries like France and Germany, the idea of someone not owning any real estate isn’t unusual at all.
Easy there, partner. Yup: some investors may prefer to invest in real estate via the stock market, buying shares in companies which own properties and act as landlords, generating income in the form of rent. Because they’re listed companies, of course, the values of their stocks are subject to daily swings…
But these companies are also “asset-backed” – i.e. they own real estate which investors can see and touch, which has a relatively stable value – and which the company can sell if it needs additional cash. That means their investors should be less likely to take flight in times of market turbulence than if they were backing, say, some tech companies whose assets aren’t as tangible (how do you touch a website?).
In an economic downturn, however, it’s worth remembering that property prices may fall as well as stocks’ – potentially hitting you with a double whammy.
It’s no secret that the value of land – and, by extension, property – in the UK has increased over time. Islands have limited space, after all – and a growing population means more demand for the same supply. But just how has that affected prices?
It depends on your frame of reference. But if you begin in 1989 (when you, dear reader, were likely a babe in arms, if that), UK house prices have risen 308% – while the UK stock market has only risen 228%. Along the way, of course, there have been significant dips in the value of both. For example, starting your measurement in 2000 (just after the burst of stocks’ dotcom bubble) would make house prices the clear outperformer to date – whereas the returns from buying a house in 2008 would have been outshone by stocks’ come 2014.
Note that in the above chart, we haven’t included income some property owners would’ve generated from renting out their properties. But to make it fair, we’ve also only shown the change in price of FTSE 100 stocks – and not included the additional return investors would’ve received from dividends.
If you needed any more evidence that it’s all about timing, look no further than analysis from investment bank Credit Suisse. By one measure, investing in the UK stock market in 1900 would’ve averaged an annual 5.5% return over the subsequent 118 years, compared to property’s 1.8%.
Buying a property that you live in is an investment, since you benefit from any increase in the property’s value over time. But you can’t live in more than one place at once. Let’s turn our attention for a moment to buying a domestic property that you intend to rent out – a.k.a. “buy-to-let”. With such an investment, you aim to make money in two different ways: through growth in the property’s value, and through rental income that exceeds any mortgage payments.
One of the key benefits of investing in property via buy-to-let is control. As the owner, you decide the fate of your investment: if and when to sell, how much rent to charge, and what shade to paint the front door. You’re also generating rental income over time – and if you have long-term tenants, it’s a relatively stable source of income (one of the reasons buy-to-let is very popular among retirees). And, of course, if your property increases in value, you stand to make substantial gains if you choose to sell.
The large deposit often needed to buy a house or apartment can, of course, be off-putting. With buy-to-let purchases, the typical deposit required in the UK is 25% of the property’s price. An average property in London, for example, would require a £118,000 deposit – too pricey for the average Brit, especially if you’re paying a mortgage to keep a roof over your own head. And then there’s stamp duty to consider...
Once you get through the research and expense of a property purchase, conclude negotiations with the seller, and sign off on the paperwork with the lawyers, there’s also the ongoing time commitment of managing your tenants and their demands. You can do this yourself, or pay a property management firm to handle it for you – in which case you forfeit control, as well as some of your rental income.
That might be a bigger bone of contention than it once was, thanks to recent UK tax changes which increased some landlords’ rental-related tax bills. Many are now making less profit than they used to from their buy-to-let investments – and some might actually be losing money overall.
One popular way to invest in property is through real estate investment trusts (or REITs). These were introduced in the UK in 2007 to provide an easier way for people to invest in property – and many are listed on the stock market.
At least 75% of a REIT’s profits must come from property rental (as opposed to building), and they’re required to distribute 90% of their property rental income to investors as dividends. This reliable form of income (since tenants’ leases are often agreed for years ahead) can make REITs an attractive investment.
REITs typically own large portfolios of commercial property, providing investors with some diversification. But ultimately, the types of properties they own are key to their performance as an investment. For example, real estate investment trust SEGRO focuses on properties like warehouses – vital infrastructure for booming ecommerce operations, which have led to it growing earnings in recent years. On the other hand, over 50% of British Land’s income comes from retail tenants – and many of those in its monster malls are being frequented less and less by shoppers.
There are two types of REITs to be aware of, each with different features. “Open-ended” REITs don’t have a set number of shares – new shares are created for buyers whose money is added to the trust. When they sell, those shares disappear. One key risk is that several large sellers at once could force the REIT to sell off properties in order to free up cash to return to investors. “Closed-end” REITs, by contrast, have a fixed number of shares – like most public companies which get onto the stock market through an initial public offering.
Investors who prefer to avoid the stock market might look to get involved in a private property fund. These pool together individual investors’ money to buy real estate, managed by a team which charges investors a fee – and often a share of any profit – for the privilege. Such funds aren’t very accessible to the average investor, with large minimum amounts required precluding all but the wealthiest of individuals from participating.
Investors in property funds typically agree to having their money tied up for a set amount of time – so this option offers less “liquidity” than if they’d invested in, say, a publicly traded REIT, in which investors can buy and sell shares at will.
Recent years have seen several upstart tech platforms looking to democratize access to property investing. Their services can be split into two main types:
Investors who own a share of a property – as with stocks – stand to make a profit when values are rising over a long period, along with a share of potential profits from rent (a bit like a stock’s dividend). Of course, ownership also carries the risk of losses if property values drop.
Investors who make property-backed loans lose the potential for windfall gains, but gain access to predictable returns over shorter periods – no matter whether house prices rise or fall. And if the lender defaults, the property can be sold to pay you back.
As well as opening up property investment to those without huge sums of money (or the time to look after tenants), the diverse bunch of new property investment platforms offer something for investors of diverse risk appetite 😛 For example, some platforms let risk-comfortable investors buy into individual properties. Other platforms, meanwhile, allow investors to spread their cash across several properties, creating some diversification.
There may also be tax benefits, depending on the type of property investment you make. For example, some platforms offer tax-free investing by classifying property loans as “peer-to-peer” investments – which don’t attract a tax bill if made through an Innovative Finance ISA.
Several of these new property investing platforms are aimed at experienced property investors – and might not suit the average person. And as with the private funds mentioned above, you may have to agree to tying up your investment for a set period of time, meaning you won’t be able to withdraw funds immediately. Furthermore, you’ll forgo some of the control you’d otherwise have if you invested directly into a property.
Before crossing the threshold into property investing, here are a few things to consider…
How much cash do you have to invest in property? Historically, you needed enough money for a deposit to begin your journey up the property ladder by purchasing a property directly. But today, there are platforms which enable you to become a property investor with much smaller sums – in some cases as little as £100.
As with investing in general, you can choose to be very hands on (a.k.a. active), hands off (a.k.a. passive), or a mix of the two. Active property investment involves buying a property yourself, maintaining its upkeep, and managing tenants – as well as their often numerous demands 😒 Passive property investors pay professionals to acquire and manage properties for them. And if you’re Upstairs, Downstairs you might buy a property yourself – but pay someone to deal with your tenants when the plumbing packs up.
Keep in mind when and how quickly you may need access to your money. With traditional property ownership, that could involve a protracted search for a buyer willing to pay what you’re asking. Certain private funds and investing platforms can also lock up cash for extended periods. REITs can be bought and sold easily – they’re highly “liquid” – which might better suit some investors.
How can you best fit property into a balanced investment portfolio? In practice, the vast expense involved in traditional ownership of bricks and mortar means it can easily end up accounting for the lion’s share of your investments. Even the uber-rich have a chunky 21% of their money tied up in physical property (excluding main and second homes), according to estate agent Knight Frank’s 2019 wealth report. For non-homeowners, our handy guide might help you figure out how much of your nest egg you should sensibly invest in shares of property or property-backed debt.
There you go: we’ve laid the foundations for your property investing journey. But before we hand over the keys, a few final thoughts:
Disclaimer: These articles are provided for information purposes only. Occasionally, an opinion about whether to buy or sell a specific investment may be provided. The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment advisor.