Property Investment in 2020: Is it “Safe As Houses”?
Property Investment has long been a favourite expat investment. This is for good reason. Especially in these times of low interest rates. Property has the twin benefits of generating an income as well as the potential for capital growth. In this post, I look at different types of property investment and ways the ways to invest.
Types of Property Investment
The two main categories of property are residential and commercial.
Residential Real Estate
Most of us will be familiar with the residential property market. This the market which many people have invested in via the buy to let market. Taking my home country of the UK, investment in this area has been so strong in recent years there have been additional taxes imposed on investors when buying an investment property. The allowances and exemptions on rental income have also been modified to the detriment of the investor. These changes and yields under 2% have not stopped investors buying within the commuter belt of London [source: Totally Money]. Outside of the South East of England yields are better.
Commercial Property Investment
The commercial market may be less familiar. Commercial property investment subdivides into three main sub-sectors: retail, commercial and offices. The tenancies are long term, perhaps up to 25 years with break clauses on either side. Rental income is often linked to inflation and the tenant may be responsible for the site whilst they are there.
Commercial property yields vary according to the location and type of property but generally, they are higher than residential yields.
Investing In Property
Adding property to a portfolio reduces the risk of the investment portfolio overall. For most people buying property will involve a substantial financial commitment.
Many investors borrow money to help with the cost of purchasing. Using loans increases the risk associated with the investment. If you buy a property without a loan and it rises by 10%, your return is 10%.
If you use a loan equal to 75% of the property price, and the price goes up 10%, you have increased the value of your equity by 10% / (100%-75%) = 40%. In figures, a property bought for £100,000 with a loan of £75,000 would require an investment of £25,000 (ignoring taxes etc.) If that property is now worth £110,000, the equity in the property is now (110,000 – 75,000) = £35,000. The original equity was £25,000. Therefore the growth of (35,000-25,000) = £10,000 or 40% (10,000/25,000). Equally, if the property value fell to £90,000, the investor would have lost 40%.
Buying a commercial property requires a much larger investment and is not something many investors do on their own. They tend to obtain exposure to this asset class using a collective investment such as a fund or exchange-traded fund (ETF).
Investing in Property Directly
Buying a property direct has a number of advantages and a few disadvantages:
- It is your property
- You choose the property
- Capital Gains and Income are yours
- You can live in your property if you wish.
- Acquisition costs are high (5-6% of the purchase price in the UK, higher elsewhere)
- Yields (income/value) are currently low
- You are responsible for finding a tenant (or you pay someone)
- You are responsible for the maintenance of the property to Health and Safety requirements
- Property is relatively illiquid, sales can take months
- You cannot sell part of a property if you need some money
Investing In Property Via A Fund
- Greater diversification of holdings, which lowers the risk
- Professional management of the properties
- Valuation services built-in
- Ability to sell some of your investment in property
- Greater liquidity than direct investment
- Exposure to markets not available directly, e.g. commercial and foreign markets
- On-going charges are higher than direct investment
- Cannot live in the property owned by a fund
There has been some controversy about investment in some types of property investment fund. Historically, property funds have been ‘open-ended’. This means investors could buy and sell their investment frequently, sometimes daily. However, the underlying asset of the fund are not so easily sold. Consequently, this mismatch in liquidity meant that in times of great market uncertainty, investors were not able to access their investments and some fund managers suspended trading of their funds.
A better solution to investing in property is a ‘closed-ended’ fund. This type of fund is more like a share. Value is based partly on demand and supply. Examples of closed-ended funds are Real Estate Investment Trusts (REITs) and some ETFs. They do not have to trade the underlying assets in order for investors to realise their investment. Stockmarkets are used to match buyers and sellers. Where there are few buyers, prices may fall significantly or trading may not be possible.