Investing in property is an attractive proposition for many people aged 30 – 60 who have surplus income to save, and who are looking for an investment opportunity.
Property investment offers the prospects of a return which will significantly outstrip the returns offered by savings accounts – which haven’t paid reasonable rates since the 2008 financial crisis, when central bank intervention led to artificially low interest rates.
That being said, traditional property investment is a huge blackhole of time and energy. Investing is very popular despite:
- Searching for a property
- Raising any additional funds from a bank
- Carrying out valuation reports and land & building surveys
- Considering any improvement works
- Evaluating the attractiveness of a local area and future growth in demand.
Then there’s the transaction itself, which can take over a month to actually ‘complete’ and become legally certain. Buying a property certainly isn’t the safest of investments. Any property investing book will confirm this.
This makes property investment quite intimidating, and makes it very difficult to invest a smaller sum such as £20,000.
Buy-to-let mortgages are typically only offered on 75% of the value of a property, or less. This means that a £20,000 sum would not enable the investor to acquire a reasonable property for rent. It effectively locks small investors out of the market.
However, this isn’t the end of property dreams, as I will explain how to invest for property returns without directly buying a property.
Property investment: Real Estate Investment Trusts
Real estate investment trusts are a type of ‘fund’ which follows rules about what it can invest money in, and what it does with the proceeds from rental income.
These rules are in place because Real Estate Investment Trusts (known as REITS for short) are given generous tax breaks which reduce the amount of tax paid by the fund itself. In exchange, the fund must behave in accordance with requirements such as the need to distribute 90% of rental income to investors in the form of a dividend.
REITs (See definitions) are publicly listed funds, which means you invest in them via the purchase of shares through a stock broker – just like any other equity investment.
The key difference between a REIT and other funds, is that a REIT will only invest in residential, commercial and industrial property. Depending on the nature of the fund, it may invest in a mixture of development and mature property portfolios, meaning its total return can be a combination of property yields and speculative profits from construction projects running on time and to budget.
The tax status of a REIT is so important because without those tax breaks, it would be very ‘inefficient’ to invest in property through a fund.
Whereas a landlord will only be taxed on their rental income once – in their personal tax return, a fund owner could otherwise have a harder time. The income would first be taxed inside the fund at the corporation tax rate, and then when distributed as a dividend, this would be taxed again as dividend income on an investors tax return.
So REITs allow investors to neatly avoid being taxed twice on rental income.
They can then enjoy the other benefits of collective investment schemes:
- Hands-off professional management – the REIT runs autonomously and will not require you to even lift your finger
- Instant diversification – a REIT will naturally invest in a large portfolio of properties, meaning that rather than your fortunes being tied to a single piece of land, you can spread your risk across the whole country and very different types of properties.
Investing in a REIT is not the same as investing in a buy-to-let property yourself, for many reasons. But another distinction is leverage. Whereas a buy-to-let investor may use £3 of bank loans for every £1 of cash they spend on a property, REITs have considerably lower borrowing, and therefore the returns of the underlying assets will not be as supercharged as if leverage was used. You have a lot more choice over how much to invest in property though.
However, consider that the market value of a share in a REIT can still be quite volatile if investors expectations of the long term returns of property changes dramatically. The value of a share today is the discounted sum of all future returns, therefore if a glorious future suddenly sours, a REIT investor can see this reflected in a sharp downward adjustment in the price other market participants are prepared to pay for their REIT share. Of course, this happily also works in the opposite direction too.