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Alternatives to Direct Property Investment

Residential property investment

UK residential property has been the best performing asset class in the last 50 years according to the Barclays Capital Equity Guilt Study & ODPM housing statistics. These figures showed that in real terms (after inflation) £100 invested in a portfolio of shares in 1930 would have grown to a little over £363 by the end of 2004 compared with £767 if that same amount had been invested in residential property.

Despite this, it has been very difficult to invest indirectly in the residential property market.

Why have investment funds not invested in residential property if the returns are so good?

There are a number of reasons why professional investment funds have stayed away from direct investment in residential property. Firstly, the whole area of private landlordism has been a real ‘political hot potato’ up until the last 10 years. Housing was seen by some members of the political classes as something not to be profited from, like the NHS. The very idea of private investors making money out of peoples need for housing was seen as morally wrong. As a consequence the Labour Party for years had introduced a whole series of restrictive Rent Acts, which prevented landlords charging market rent as well as obtaining vacant possession. An investment in an asset that the investor was prevented from selling at its true market value (with vacant possession) was obviously not something the institutions wanted to get involved in.

The other factor that put them off was the relative intensiveness of the management process. An investment fund can invest £5+ million in a single commercial building, with one tenant who remains for 25 years. A comparable sum invested in a residential property could involve having to buy and set up say 50 individual properties at £100,000 each. Then each of these properties & tenancies would have to be managed, all this is time consuming and expensive.

As a result of this ambivalence to the sector, very little effort has been put into research that compares residential investment performance against other asset classes. Further details on how investment in residential property compares against other investment classes can be found in the Landlords Bible.

Why not invest all my money in residential property if it performs so well?

There are a number of reasons why it always good to have a range of investments. If you already have a large ‘buy-to-let’ portfolio of residential property without much of your assets invested elsewhere, you may wish to consider diversifying your investments. The classic phrase is ‘don’t carry all your eggs in one basket’. Investing is much the same. Whilst over the years I have always held most of my assets in residential property; I have also held a proportion in alternatives such as shares and deposit accounts. As an active investor I am always looking for new and innovative methods for diversifying my portfolio. The theory is that if one investment isn’t doing so well, as was the case for shares for a number of years. Then some of the other investments are doing a lot better. The result you hope is that overall your capital keeps on growing.

You may still be keen to invest more funds in residential property but feel that you don’t have the time or skill to do it yourself. What then?

Alternative to direct property investment

There are a number of drawbacks with direct property investment that those already in the sector are all too aware of. This isn’t to say that these are not compensated by the huge benefits of successful residential investing. However, it’s always good to be aware of them so that at least you can make informed decisions about what to do with your capital.

The investment drawbacks of holding residential property directly are:

* The costs of acquisition can be high, typically £2000+

* The minimum capital required is large, with a minimum amount for a deposit, acquisition fees, set up costs of probably £20,000+

* The timescales for buying and selling property is long and the timing uncertain i.e. it takes many weeks and you rely on finding a willing buyer or a property that you want at the right price

* Management time is far greater than non-direct investment

* Generally timescales are long. Residential property is a long-term investment where your capital is tied up and cannot be accessed unless you remortgage

Therefore, as well as considering direct investment are there alternatives and what are their advantages?

There are a number of ways that it is possible to invest indirectly in the residential property market but first, what are the advantages of indirect investment?

1. the size of the investment can be much smaller than direct property investments, rather than thousands it can be hundreds of pounds

2. the investments are much more liquid so it’s easier to put money in and easier to take funds out

3. there are little or no management involvement in the investments

4. the entry and exit costs from the investment are also a lot smaller

Current Opportunities

The strong performance in residential property has led to a number of innovative schemes looking at ways that investors can invest in residential property without having to do it directly.

Stock market

The most obvious way to invest indirectly in residential property is through the stock market. There are a variety of companies whose performance depends to a greater or lesser degree on the residential property market. For instance, there are the numerous quoted house builders which as well as carrying out development, also hold large land banks. The asset value of these companies often varies in line with the underlying value of residential property as land costs generally rise and fall in sympathy with house prices. Another company to consider is Grainger Trust http://www.graingertrust.co.uk . This company is the UK’s largest quoted residential property owner, with over 12,000 homes. As well as owning property they are also active in other related areas such as equity release, asset management and house building. Opening a share dealing account is a lot easier than you might imagine.

Residential trading exchange OPROMARK

A new initiative which may offer an alternative to direct property ownership is a company called Opromark. This company is described as the world’s first exchange for trading fully securitised properties. The way the exchange works is that a residential property is owned by a Single Property Company (SPC). This is then owned by Opromark members. Each SPC is managed by a property professional who acts as the managing director responsible for the management of agents who let the property on the shareholders behalf. Properties are let and the rent is then distributed to the shareholders in the form of a monthly dividend.

The individual shareholders are free to buy and sell shares in each SPC at any time.

This scheme looks as if it could be an interesting alternative to direct property ownership. One of the obvious problems could be the liquidity of the shares, which means that they can only be transacted on a matched bargain basis. This effectively means you can only buy and sell if you can find other shareholders to either buy or sell stock. It is early days and it’s probably worth seeing how the project progresses before committing too many resources to it.

Funds

The Diverse Fund launched by Cordea Savills, the investment arm of the property company Savills Plc offers the opportunity to invest in student halls of residents, residential homes for doctors nurses & housing association properties on long leases. It is a Jersey quoted Oeic (Open ended investment company). It can borrow up to 70% of the value of it’s assets and has a current value of £10 million. Minimum investment is £10,000. The fund aims to capitalise on the growing popularity of student accommodation as an investment asset. The fund has a 5% yield and the projected capital growth in the fund is in excess of 10% per annum between 2006 and 2010.

Sipp (Self Invested Personal Pension)

Great things were promised by the Government for personal pension holders as a result of ‘A-Day’ at the start of the 2006 tax year. This catchy expression was meant to herald in a raft of new ways of investing for your retirement through a SIPP, including the ability to hold residential property in it. Not for the first time the Government failed to deliver. In a dramatic last minute U turn; it removed residential property from the list of qualifying investments. This dashed the hopes of many existing and potential residential investors. However, in the latest twist to the saga the regulations were ‘tweaked’ by the budget to allow the direct holding of residential property in a SIPP but only through a syndicate. The qualifying criteria are quite restrictive in that the syndicate must comprise of 10 or more people and that the properties cannot be used by syndicate members. In addition, the SIPP must be worth £1 million or more and have 3 or more properties. No single property should be worth more than 40% of any individual SIPP.

REITs (Real Estate Investment Trusts)

REITs have been available in the US and Japan for a number of years and are very popular with investors as they provide a transparent way to invest in property but without the difficulties of direct ownership. The attractions of REITs to the investor and property company is that they pay no corporation tax on their rental income. From the 1st Jan 07 UK property companies are free to convert to a REIT. In returns the companies under the regulations have to distribute 90% of their income to investors. This means that yields on the shares are likely to be high compared to other equity investments quoted on the stock market. The other attraction to REITs, which ultimately can invest in residential property as well as commercial property; is that they will be able to be contained within a PEP or ISA. This allows any income and ultimate capital gains if the shares are sold to be received tax free.

In general, it is likely that the number and variety of schemes available for indirect residential investment will increase as institutions and companies continue to explore ways of allowing investors to access this popular and strongly performing asset class. If the US experience is anything to go by, one of the developments could be the emergence of specialist REITs that invest purely in residential property giving small investors a genuine opportunity to invest indirectly in UK residential property without the drawbacks of direct ownership. Watch this space for developments and keep up to date with the latest news through Property Hawk’s news service.

Commercial property funds

As I have already commented on the fact that institutional investment funds have traditionally avoided residential investment but at the same time have long been large investors in commercial property. Commercial property is yet another way of diversifying your investments. It has shown some strong returns in recent years. Investment funds come in a variety of forms including investment trusts, unit trusts and oeic. They provide a mechanism for individual investors to have a share in the capital appreciation and income derived from investing in a range of commercial property.

Financial Advice

If you find all the talk about investment returns and capital boring and confusing. Then, maybe it is time that you sought professional advice. To source a IFA(independent Financial Adviser) try http://www.unbiased.co.uk which is the website for IFA (Independent Financial Advisers).

IFAs are the only advisers that are able to advise and select from the whole range of investment products on the market. They are bound by the Financial Services Rules, which ensures that any product that they recommend should be suited to your personal circumstances.

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