Investing in Property
A basket full of smashed eggs series: Investing in Property
Last week we looked at the potentially safer ‘egg’ of fixed-interest investments. This week, we’re looking at one of the most popular types of investment: property.
There are lots of ways to invest in property. The main differentiating factor is between investing in residential (i.e. properties that people may live in) or commercial property (i.e. properties that are used by businesses and shops. The biggest difference between these two is that commercial property is normally much more expensive but also has the potential for higher returns.
The next factor is how to actually buy the property. The most popular way, of course, is to buy the property (either outright or by using a mortgage) and rent it out to someone. This gives a ‘yield’ which produces a regular income each month. The next most common way is to invest in a property ‘fund’. This is a collective investment into which lots of people put their money. The manager of the fund then invests in lots of different properties and distributes the profits from these to investors.
Here is what that looks like:
History of investing in property
Land ownership has been a hot market for hundreds of years now. Ever since the days of serfdom in the Early Middle Ages, people have taken ownership of land and have used this land to make a profit.
As property prices have gone up and down in history, the demand for owning property to make a profit has fluctuated. In 2007, for example, the sub-prime mortgage crisis (which lead to the global financial crisis) meant that many people were paying more on their mortgage than their house was worth.
A big event in the history of property investing came on the 14th September 1960, in Washington D.C.. The President of the USA at the time, Dwight Eisenhower, signed an act that brought Real Estate Investment Trusts (REITs) to life. These are collective investments where investors pool their money into real estate projects, and there are lots of these around today.
The biggest property fund in the UK today is the Legal & General Property fund, which is worth about £2.9bn as of April 2020.
Advantages of investing in property
The benefits of investing in property are as follows:
- Control – With direct property investments, the investor is completely in control of the property and how much they want to charge in rent or what they would like to do with it. With other types of investments, money is placed in the hands of fund managers to make the decisions.
- Bricks and mortar – Some people like the security of knowing that they own a tangible (real) asset that they can touch. This is why it’s called real estate!
- Steady income – The income received from renting out the property could provide a nice extra income, alongside paying for the mortgage on the actual property.
- House prices – House prices have historically risen. This means profits could be lucrative when selling the property in the future.
Disadvantages of investing in property
Investing in property also has its drawbacks:
- Illiquidity – Property is tangible and can’t just be sold back to the fund manager (like funds) or companies (like shares). The length of time it takes to sell a property means it could be a long time before you can get your money out when you need it.
- Suspensions – The above problem is a big issue for those investing in property funds. When things are going well, all is dandy. But, when times are tough, some property fund managers close the funds, effectively ‘locking-in’ investors so that they can’t get their money out for a period of time.
- Effort – Finding the perfect tenant is a hard task, and when you have a bad one, your tangible asset is at risk. Not only this, but the paperwork and physical effort involved in renting out a property can be strenuous.
- Taxation – Direct property investment has been flying against various tax headwinds in recent years.
Future of investing in property
Investing in property isn’t without risk. All it takes is for a drop in house prices or an increase in mortgage interest rates to turn the situation upside down.
Property in our view remains a long term investment and one where the disadvantages should always be taken into account as well as the advantages.
The value of investments may fall as well as rise, you may not get back what you put in.