Not a day goes by without property prices making the news.
Residential property is a national obsession, and at over £7trn in value and representing over 50 per cent of the nation’s wealth, the UK housing market is larger than the UK equity and commercial property markets combined.
The rewards have been outsized for those able to participate in residential property as an investment, with £1.4trn of assets currently in buy-to-let (BTL). Strong returns are often referenced as the sole reason that 2.5 million people participate in this market, but it also has many attractions with regard to risk.
Press coverage will inevitably focus on changes in house prices, but residential income has offered steady, consistent returns that broadly correlate with consumer inflation, and behaves well during downturns relative to income from commercial property.
While everyone knows that property prices go down as well as up, many value the tangibility of the investment and, with 80 per cent of the asset class unlevered, it is relatively low volatility versus the equity markets.
Source: CML Landlord Survey 2016
This attachment to property remains strong – 49 per cent of people think it is the best way to save for retirement, according to a recent study by the Office for National Statistics.
But against a backdrop of tightened lending, growing tax charges, more onerous tenant legislation and faltering capital values in some markets, it pays for individual investors to consider the specific risks of their BTL investments – the traditional way of investing in residential.
Many risks associated with direct property investment are easily grasped by most investors.
They concern asset selection (what type of property, where, and how many), value preservation (property maintenance and tenant management), sources of financing (mortgages and tax treatment – particularly in light of the shock change to the rules in 2015), and timing (when to buy or sell, and any opportunity costs to tying up capital).
Though they may be generic, these risks are still hard to manage.
Key points
- The UK population likes to invest in residential property
- Buy-to-let has become less popular due to tax changes
- Investing in a Reit or via crowdfunding platforms are alternatives
Take the first category: identifying a good property in a good area is time-consuming for the average investor, and investing ‘away from home’ is harder still.
Unless your client is buying a portfolio of properties as a semi-professional, most end up purchasing an individual property around the corner from their primary residence.
Close to home
The Council for Mortgage Lending Survey in 2016 showed that landlords overwhelmingly own investment properties close to home. Not only does this mean missing investment opportunities further afield, it also means doubling-down on concentration risk in a particular geography.
While rental income across the asset class is relatively dependable, rental income for a given property is not. Individual investors must shoulder the burden of voids, maintenance and tenant disputes, making the cash required to maintain the investment potentially lumpy and unpredictable, not to mention the hassle involved.
Headline figures on investment returns can be particularly misleading for this reason: rarely do investors have a true, bottomed-out view of their net rental income, including the full costs of letting or management, nor do they make provision for rental voids, insurance, maintenance and future capital expenditure.
Add in the costs of financing and there is a fair chance the numbers will not justify the risks of individual buy-to-let investment, particularly as leverage amplifies downside risk and successive governments have shown their willingness to disincentivise BTL through HMRC.
All this would matter less if the sums at stake were small. But today the entry ticket for investment in residential property is – at a minimum – the price of a deposit.
For those unwilling or unable to borrow, the average UK house price is now greater than £200,000.
Despite the attractions of the residential property market from a risk point of view, the traditional means of access via buy-to-let introduces its own risks, which are all magnified by the sums at stake.
Crowdfunding approach
One solution, popularised by financial start-ups, has been to lower this initial investment hurdle by facilitating collective ownership in individual properties through an online platform.
A number of these ‘property crowdfunding’ portals now allow investors to buy fractions of individual properties, starting at just £100. You never get physical access or control of the property as the investment is purely financial, but in return investors are relieved of the burdens of management.
This crowdfunding approach also introduces its own risks.
It is less tax-efficient than BTL, with corporation tax on gains and income, in addition to personal tax liabilities on top.
Moreover, trading stakes in individual properties on a proprietary platform introduce risks around asset valuation, investor liquidity and fees, which can vary dramatically.
Many opportunities are levered, and investments have displayed significant price volatility versus the performance of the property assets themselves – potentially interesting for some, but a clear additional risk versus the property market.
Traditional solutions, like real estate investment trusts (Reits), offer a tried and tested way to lower the investment hurdle, and they have the benefit of being eligible for tax wrappers such as Isas and Sipps.
Reits differ from crowdfunding insofar as they are regulated companies holding portfolios of properties in which one buys shares, meaning investors have a claim against the entire assets of the company rather than just an individual asset.
Reits are highly regulated with regard to diversification, governance, accounting and asset valuation, which is another benefit of opting for this more traditional mainstream vehicle.
The assets that Reits contain can vary tremendously, with many of the better known companies working principally in commercial property.
There is increasing interest in residential property Reits, which focus on buying and holding residential property exclusively – the closest alternative to direct property investing. These provide investors with a means to spread an investment across a portfolio of properties away from home, in a tax-efficient, diversified, hassle-free manner.
With BTL on the way out, all is not lost for investors who still value the risk-reward profile of residential property. As always, investors should pay attention, not just to the risks of the asset class itself, but also to whether the way in which they invest amplifies, or diminishes those risks.
Simon Heawood is chief executive of Bricklane
