An introduction to property investment

Introduction

For many people buying their own home is the biggest single investment they’ll make – it’s also one of the easiest to understand. As well as being tangible, you can witness the capital appreciation of your asset as your house price rises. You can also see its relation to the rest of the market when you compare your house price rise with those in different parts of the country (or even street).

In a market where many consider stocks and shares complex and risky, perhaps it’s unsurprising a trend emerged for investing in buy-to-let properties in the face of dwindling pension expectations.

But, as buy-to-let prospects start to cool down and more investment options reach the market, investors are beginning to consider other ways of putting their cash into the property investment market. And with the introduction of REITs in January 2007 there is an even greater focus on alternative options.

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Investing direct or indirect?

The first thing to consider with property investment is should you invest direct, ie by buying all or part of a physical property; or indirect, ie by investing in stocks and shares or some other investment vehicle?

Investing direct in either residential or commercial properties may be desirable for its tangible benefits but the high entry costs are a huge barrier, particularly for first time buyers.

While indirect investment may not provide a home for you, or have the same feel good factor, it does allow the investor to spread money across several properties, therefore spreading the risk. In addition, the investments are often easier to sell as there’s no need to find a buyer for an individual property. There are also no direct management responsibilities of the property.

These are all important considerations which only you as an individual will be able to evaluate.

To get further financial advice on which options are most suitable for you, we recommend you find an adviser.

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Residential or commercial property?

The second factor to consider is whether to invest in homes or commercial properties. What sets them apart isn’t just size and price, as the two types of investment can work in different ways financially. For example:

• tenants of residential properties are generally on relatively short renewable leases, but commercial tenants typically sign long-term contracts, with periods of more than ten years not being quite common

• tenants of commercial properties are usually liable for repairing the property themselves but landlords of residential properties usually remain responsible for repairs

• returns from residential properties have largely been linked to rapid increases in house prices, whereas the significant component of commercial property returns tend to come from their rental income.

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Residential property

Many of us don’t consider the purchase of our home as an investment vehicle as such, to the extent we hope to live in our property rather than sell it. However, with all the perceived value in the buy-to-let market, many people consider buying a second property as an investment vehicle. And despite the recent cooling of the market, there are still several factors supporting buy-to-let investments. First, the population in the UK continues to grow. In addition, Government analysis implies that, unless house building rates increase, just three in ten households will be able to afford to buy their own homes by 2026, thus providing a ready market.

Residential property investments are, however, often extremely susceptible to even relatively slight interest rate rises. In addition, buy-to-let strategies can be vulnerable to downturns in regional economies or even local government policies, for example school and hospital closures or council tax increases.

There are, however, signs of residential buy-to-let strategies becoming more sophisticated, as individual investors seek out more reliable, long term returns. Some professions, for example, might include investing in a place of work, such as a doctor’s surgery or the premises for a restaurant. Alternatively, investors are looking at options which might include investment in student halls of residence, nursing homes or housing associations, although this type of investment is more usually approached through a collective investment fund.

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Commercial property

Because of the size of the financial commitment required, investment in commercial properties has tended to be the domain of property companies and institutional investors. The introduction of UK REITs back in January 2007 has made commercial property investment more accessible to the individual investor.

One of the interesting things about property as an asset class is that its performance is not linked to how shares and interest rates perform. For example, if shares and interest rates fall, property prices won't necessarily fall. Conversely, property prices can fall when all other asset classes are going up in value. This makes property a useful way to diversify investments and spread risk.

Within commercial property portfolios you should look to have diversity as well as a balance between the three sectors: office, industrial and retail. Diversity is important because market forces affect each sector differently. Ideally any commercial property investment would have an income in line with market rents and the value of the property would rise (but of course this can't be guaranteed).

This potential for diversity across a number of levels is an important reason why investment in commercial property is preferred by a number of investors. And, as direct investment with genuine diversification in this market would require upwards of £50 million, clearly this is beyond the reach of most individuals. This is why most individual investors invest in commercial property via one the various types of investment funds or trusts, as entry levels are lower and therefore manageable.

However, this type of investment is clearly more complex than residential property, and investors require a detailed understanding of how such indirect property vehicles work, the strategic objectives of such schemes and the associated risks.

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Overview of the market

While much residential property investment is driven by expectations of the growth of its capital value, commercial property returns are more focused on their rental income. The medium to long term appeal of this kind of investment is linked to the fact that most commercial leases tend to be significantly longer than residential ones, and that commercial rents can often only be revised upwards.

The commercial property investment market comprises of three principal sectors:

Retail – shops and shopping centres, for example Bluewater shopping centre in Kent
Offices - from individual offices to entire buildings such as London’s gherkin
Industrial - warehouses and storage units

In addition, there are a number of smaller sectors, such as leisure (ie restaurants, pubs and hotels, leisure parks).

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Current investment vehicles

Until recently, investing in commercial property was impractical for private investors because of the large lot size, relative scarcity of retail products and the fact that units could be difficult to sell. With an increasing interest and many new commercial property funds and vehicles focussed on private investors this is changing rapidly so that and in recent months and years, commercial property funds have been a very popular choice for investors.

Individual investors

For smaller investors looking to invest a few thousand pounds in commercial property, the fund option has been and is likely to remain the most popular choice. The introduction of REITs has however presented a new set of choices: whether to invest in a fund that buys and owns commercial property, or in a fund that buys shares in REITs (that is invests in property companies rather than directly in property), or indeed in one that offers a mixture of direct investment and property shares.

Commercial Property Funds also offer small investors the opportunity to invest in markets outside the UK which may be useful for those seeking further diversification.
 
Funds come in a number of different structures including unit trusts, open ended investment companies (OEICs) and investment trusts, all of which have particular pros and cons, that should be considered before choosing a particular fund. 

If you’re unsure of where to invest or which investment vehicle to use, we recommend speaking to a financial adviser.

find an independent financial adviser

Larger investors

For larger and more sophisticated investors, the choice of investment is somewhat wider. There are a number of products that offer the chance to invest in property investments through a limited partnership structure. These products typically have a minimum investment of £25-50,000 and often comprise of a single property. The underlying property asset acts as security for a bank loan and reduces the need for equity. Such products can be difficult to sell, come with significant marketing restrictions and, in practice, are only available to investment professionals.

For investors with substantial assets, it is possible to buy commercial property directly, although this will only be viable for a small number of investors. Even for these investors, there remains the issue that it will be very difficult to achieve any diversification.

It is possible to buy property directly within a Self-Invested Personal Pension (SIPP) and, in this case, direct investment may be feasible for a larger number of investors. However, diversification will still be difficult to achieve and specialist skills will be required, although some SIPP providers do provide specialist property services.

Existing property investment vehicles include:

• unit trusts
• open ended investment companies (OEICs)
• investment trusts
• listed property companies
• offshore funds
• venture capital trusts
• exchange traded funds
• pension funds
• life funds
• UK limited partnerships

For REIT investments only, see: Reita fact sheet on REITs and how to invest in them

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Risk warning

Please remember that the value of property investments can go down as well as up and past performance isn’t necessarily an indicator of future performance.

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Further reading and resources

Introductory information

How do asset classes compare – Reita fact sheet
Aimed at financial advisers and investors, this straightforward fact sheet compares the relative features and performance of cash, fixed income investment options, equities and property investment.

download fact sheet

Property investing, an overview – Reita fact sheet
Aimed at financial advisers and investors, this fact sheet provides a breakdown of the property sector, covering the drivers for growth and a summary of ways to invest.

download fact sheet

All about REITs
Read our introductory guide to REITs for investors.

read guide

Reita newsletter and document update email
Reita sends out regular updates of news and information on REITs and quoted property investment, as well as telling you about the latest documents on our site. Sign up to keep up to date with the latest information.

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More advanced information

For more advanced information on quoted property investment and REITs you can visit the non-investor sections of Reita.org. Our download libraries contain several research and information documents. Please note, some of this information is aimed at investment professionals and should not be taken as any form of advice.

Please also remember that the value of investments can go down as well as up and that past performance is not an indicator of future performance. Reita strongly recommends that investors looking for advice on where to invest should talk to a professional adviser.

visit Reita’s download libraries

funds that invest in property

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Find an adviser

To get advice on where and how you should invest, we strongly recommend you seek financial advice from a professional adviser near you.

find an adviser near you

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