There are two main types of property investment - direct and indirect, but which is suitable for you, how do they work, and where can you find investment property for sale?
- Direct property investment:
- Buy-to-let: You can purchase property with a view to letting it - this would give you both an income, in the form of rent from a tenant, as well as capital growth if the property is sold for a profit.
- Property development: Alternatively you can purchase property directly with a view to renovating it and selling it for a profit.
- Indirect property investment:
- Property fund: You can also invest in property indirectly through a property fund. If the fund performs it will provide you with an income in the form of dividends, or rental income, depending on the type of fund, and capital growth when you come to sell.
Direct versus indirect property investments
If you invest in a property fund you have exposure to property without the need for any work on your part. The fund will be managed by a fund manager. By contrast, if you own a buy-to-let property you will have ongoing involvement with letting agents and tenants, and a property development may require you to either project manage the development or undertake some of the renovations yourself. In short, if you buy a property, it is a "hands-on" investment that typically requires active involvement from the investor.
Property funds have the advantage of ready-made diversification built in, which, depending on the mix of the fund, can lower the risk when compared with a direct property investment. With a fund you also have the choice of investing in shares held in property-related companies, or in bricks and mortar.
Property investment: the potential for high returns
There is one important aspect of direct property investment that sets it apart from an indirect investment, and makes it an attractive option for investors - the fact that you don't need to find funds to cover 100% of the property value to be able to purchase. Typically you only invest a portion of the funds and the balance can be borrowed as a mortgage.
However, if the value of the property goes up, you benefit from the increase in its total value even though you have only paid for a portion of the property. This gives you the potential for high returns.
To put this into perspective, if, for example, you have £25,000 to invest, you could choose to buy shares, or alternatively you could use the money as a deposit to purchase a £100,000 house.
If shares go up by 10%, you stand to make £2,500, 10% of your original investment. However, if your property goes up by 10% you stand to make £10,000 - 10% of the total property value, but a 40% return on your investment.
Of course, in reality, it is not this straightforward. There are many costs that need to be considered when purchasing property, but this simple illustration demonstrates why purchasing property can be attractive.
It's also important to remember that the value of property can go down as well as up, although over the long-term it tends to go up. Property investment needs to be viewed as a medium to long-term investment - a minimum 7-year investment period is usually recommended.
Risks of property investment
If you need to borrow money to fund your property investment (and there are good reasons for doing this as the example above illustrates) then you will be committing to monthly mortgage repayments. The cost of your borrowing can vary over the period of your investment depending on interest rates. If interest rates go up significantly it could mean that you are no longer covering your costs with the rental income from the property. Also, if your property lies empty for any reason, you still need to find the funds to cover the mortgage repayments.
In the case of property development, if a property takes longer than expected to renovate, or takes time to sell, the cost of financing the mortgage can quickly eat into the hoped-for profit from the investment.
Property doesn't always sell quickly, and even if you are lucky enough to find a buyer for a property swiftly, the process of concluding the sale can take many weeks, or even months. That's why property is not considered a very liquid asset - once money is tied up in property it cannot be accessed at short notice.
Property investment cost implications
There are significant costs attached to buying and selling property, such as stamp duty, and agency and legal fees, and these need to be considered when you are making a decision about whether or not to invest. There are also ongoing costs attached to a buy-to-let investment - refurbishment and upkeep, the cost of drawing up contracts and complying with legislation, and mortgage repayments to name but a few. All of these should be factored in to ensure the investment stacks up financially.
Property investment and tax
Any profit from rental income is taxable at the highest rate of tax applicable to you, although many of the costs you incur in running a buy-to-let property, such as the interest on your mortgage and any agency fees, are tax-deductible.
Any gains on the sale of a property bought as an investment are subject to Capital Gains Tax (CGT). This is between 18% and 28% depending on your taxable income, and the tax applies to any profit above the CGT tax-free allowance threshold. The costs of buying and selling the property are tax-deductible.