Investing in Real Estate
Investing in real estate, or property has long been seen as being able to generate both short-term and longer-term returns. Buying houses is the most basic form of investing in property, however, it is possible to have property as part of your investment portfolio without having to invest in bricks and mortar.
Here we discuss the various ways to have exposure to property. We look at some of the benefits and disadvantages that real estate can bring as we consider another important asset class for an investment portfolio.
What is real estate investing?
“Real estate” is considered to be land and any buildings or structures on it. The buildings could be homes or residences, but could also be industrial (such as factories) or commercial (such as shops).
Real estate investing is all about generating a return from either rental income or buying and selling properties. Traditionally, this would involve directly investing in bricks and mortar which could range from buying small-scale family homes up to large-scale city tower blocks.
However, directly buying property is not the only way for investors to be exposed to real estate. In recent years there have been an increasing number of investment options that will give you more indirect exposure to the property market.
Here are the main ways to invest in real estate:
- Bricks and mortar – directly buying houses, and getting involved in property development or commercial real estate
- REITs – Real Estate Investment Trusts
- Property funds – through Exchange Traded Funds, unit trusts, mutual funds etc
- Real estate equities – buying listed companies that are exposed to the property market.
Let’s have a look at these in a bit more detail.
Bricks and mortar real estate
Whilst the focus of this article is predominantly on investment options, we could not cover real estate without touching upon the most direct way of investing in property. Buying houses and owning your own home has long been seen as a way of advancing your wealth as you climb the property ladder.
Flipping houses (repeatedly buying and selling) is one option. However, this requires consistently rising property prices to make it profitable. Failing that you could buy a cheap dilapidated property, do it up, and then sell it for a much higher price. However, this requires a lot of hard work. So, when it comes to direct property investment, most people prefer to stay in their own home and focus on buy-to-let properties.
Once settled in a primary residence, people will often therefore look to add additional investment properties to their property portfolio. When house prices are rising, interest rates are low and rental income more than covers the mortgage, buy-to-let properties can be a great way to generate consistent returns.
However, the considerable up-front costs of the deposit (can be as much as 20% of the property value), onerous administration, and punitive legislation changes, can still mean the whole experience is a chastening one. Furthermore, profits from rental income and sales are also taxable.
There are also other ways to invest in bricks and mortar. Here are just a few to think about:
- Investing in overseas property – it can be nice to have a little holiday home abroad. However, it does require a considerable outlay of funds, whilst also dealing with an unfamiliar foreign country.
- Investing in property development – although this would certainly require deep pockets.
- Investing in commercial real estate – again deep pockets are required.
Subsequently, this all sounds fairly expensive and unless you are a budding property magnate, it may not be for you. The capital requirements and administration issues can leave investors looking for cheaper and easier alternatives.
How do I invest in real estate?
Let’s now take a look at some of the indirect ways of investing in real estate. These require far less capital and are often much easier to manage.
1. Real Estate Investment Trusts (REITs)
A Real Estate Investment Trust, or REIT, is a company that owns and manages the property on behalf of shareholders. REITs allow shareholders to be exposed to property investment without being directly involved.
The benefits of being classified as a REIT is that they are exempt from corporation tax from rental income and any income from property sales. To qualify as a REIT in the UK, the company has to:
- Have at least 75% of assets involved in property rental
- Have at least 75% of the profit from property rental
- Pay out at least 90% of the profit as dividends
The first REITs were introduced to the UK in 2007 and there are now around 56 REITs listed on the London Stock Exchange. They cover a variety of sectors including residential, commercial and also healthcare. British Land, Hammerson and Land Securities are some of the most widely known REITs trading as constituents in the FTSE 100 and FTSE 250 indices.
2. Property funds
Property funds are a pool of investor money that collectively invests in real estate. This can be the buying and selling of property or the management of property for rental income. Unlike REITs there are no criteria to meet, so the fund managers decide on the best way to maximise profitability. This could be through capital accumulation or dividends.
Property funds include unit trusts, open-ended investment companies (OEICs) and exchange-traded funds (ETFs). In the UK, the funds are regulated by the Financial Conduct Authority.
3. Real Estate equities
Some property companies are listed on the stock exchange but either choose not to become REITs (perhaps due to the strict criteria) or automatically do not qualify. However, these can still be seen as attractive investment opportunities.
Here are a few investment areas that would come under property:
- Housebuilders such as Barrat Developments, Persimmon and Taylor Wimpey are popularly traded stocks
- Residential property portal Rightmove and the estate agents Foxtons help people to buy and sell properties
- Builders merchants and suppliers to the housing trade such as Marshalls and Howden Joinery.
These are all companies that have prospects very closely tied to the outlook for the global economy as well as more specifically, the UK. This can be a positive or a negative depending upon where you are within the economic cycle.
The risks of investing in Real Estate
The risks involved can be split between direct real estate investment and indirect investments.
Here are some risks of direct property investment:
- Large capital outlay/deposits– buying investment properties can require huge amounts of capital being tied up.
- Significant administrative effort – the stress of finding suitable properties or tenants, in addition to general upkeep and potential changes in legislation can render the investment high risk and potentially unprofitable.
- Investments are illiquid – selling properties or finding tenants can take weeks or even months, which can impact income
The risks with indirect real estate investing arguably come as risks similar to those that lie with broader investing in funds or equities:
- Potential management fees – property funds (such as unit trusts or ETFs) tend to come with management fees. These can vary depending on the fund, with mutual fund fees tending to be higher than ETFs.
Fund and equity prices can fluctuate – funds and equities are subject to broader market movements and can be very reactive to economic conditions.
The benefits of real estate investing
Moving on to the benefits, here are a few of the advantages that come with investing in real estate. Many of the benefits cover both direct and indirect property investing.
- Offers a steady income – this is true of both direct property ownership (from tenants) and indirect investments (fund and equities paying a dividend)
- Additional capital appreciation – property prices tend to move higher over time (although not always). Prices of indirect investments tend to fluctuate more.
- Adds diversification to a portfolio – Anything that adds diversification to a portfolio will tend to be seen as a positive. Property investments, both direct and indirect will do that.
However, some benefits come exclusively from indirect property investment. You may notice, that These tend to be where the opposite of the disadvantages of direct real estate ownership become the advantages of indirect investments. Here’s how:
- Smaller capital outlay – Buying shares in REITs means that you can invest as little or as much as you like. This also makes it far easier to spread investment capital across several assets to further improve diversification.
- Investments are liquid – The liquidity from investing via REITs or ETFs is dramatically improved due to trading on an exchange. It is easy to buy or sell the investments as you wish.
- Hold assets in an ISA – Assets such as REITs, ETFs and equities can be held under the tax-efficient umbrella of an ISA, protecting any profits or dividends from tax implications.
Real Estate Investing Takeaways
The economics of owning property and expanding a portfolio through investment properties is a popular way to improve your wealth. However, for those who have less investable money available, lack the time, or quite frankly, the significant effort required for direct property investing, there are alternatives.
Being exposed to property via funds, REITs and real estate focused equities gives investors the ownership, even if it is indirect. It can be good source of income for a portfolio and can help to improve investment diversification.
As ever though, if you are unsure, we would always suggest seeking independent investment advice.
