The property game

Property is an attractive asset class for many income-seeking investors. As long as the residence has a tenant who pays their rent on time the investment yields a cash return each month. If the value of the property increases, so does the size of investors’ original investment, thus protecting the investment from the ravages of inflation. So owning an investment property has the characteristics of equities and bonds: a regular income and potential capital gains.

There are other ways to make money from the high demand low supply in-balance of the UK’s property market. A look at the stock market shows the huge range of companies and funds that offer investors diversified exposure to the market without having to raise the sums of cash needed to buy directly.

The direct route

Owning a property has obvious advantages; not least being an asset that investors can touch unlike buying shares or bonds. But there are risks that people looking at property for investment purposes need to consider before contacting the bank for a mortgage:

• No tenant, no income. You still have to meet mortgage repayments even if the property is empty
  
• If there is a problem with the property you, or the insurance you’ve paid for, has to cough up to fix it
  
• Illiquidity. It can take several months to sell a house, so it is not ideal if you need your cash back in a hurry. And if the market is depressed you may not get back from the sale what you originally paid for the asset, even before you receive the bill for the fees associated with such transactions

Fees are about to become a bigger issue for those buying an investment property. From 1 April 2016 the one-off stamp duty tax linked to the purchase price of a buy-to-let property transaction will be 3% above existing rates. This is Chancellor George Osborne’s latest bid to help create more owner occupiers in the UK by reducing competition for first-time buyers.

With pricing rising as too many people bid for too few properties frustrations of those struggling to get on the housing ladder have become a political issue. Here’s why:

• 22% of homes in the UK today are investment properties owned by private landlords
• 9% of homes in the UK back in 1985 were investment properties owned by private landlords

Source: ResPublica, a think tank.

The details of the government’s latest attempt to deter people from buying an investment property makes difficult reading for investors looking to use their saving to add bricks and mortar to their portfolio.

Current buy-to-let stamp duty rates

Value of property	Stamp duty charge
Homes bought for up to £125,000	£0.00
Homes bought for between £125,001 and £250,000	2%
Homes bought for between £250,001 and £925,000	5%
Homes bought for between £925,001 to £1.5 million	10%
Homes bought for more than £1.5 million	12%

Source: Gov.uk

From 1 April 2016 for buy-to-let properties

Value of property	Stamp duty charge
Homes bought for up to £39,999	£0.00
Homes bought for £40,000 to £125,000	3%
Homes bought for £125,001 to £250,000	5%
Homes bought for £250,001 to £925,000	8%
Homes bought for £925,001 to £1.5 million	13%
Homes bought for more than £1.5 million	15%

Source: Gov.uk

So, if somebody buys an investment property or second home for £275,000 they will have to pay £12,000 in tax from 1 April, compared to £3,750 if they bought it today.

Property companies

If the size of the fees eating into your savings, having to meet monthly mortgage repayments or dealing with the hassle of maintaining the property puts you off investing in real estate there is another option: buy one of the 91 property companies trading on the London Stock Exchange.

Investing in the property market though a listed company means pooling your funds with other investors which are then managed by a professional. Such companies offer investors diversification through owning several assets and provide access to commercial properties. Everything from skyscrapers to offices, shops, pubs, student accommodation, self-storage and warehousing are owned by listed real estate companies, or to be precise, their shareholders. Such businesses offer income through dividends and capital appreciation in the hope that share prices rise along with improvements in property valuations.

Listed real estate’s performance over five years

Source: Thomson Reuters Datastream

When researching real estate companies the usual valuation metrics such as price to earnings (PE) do not provide an accurate reflection of a company’s performance. Nor do pre-tax profit projections, which can be affected by acquiring or selling assets.

The litmus test for real estate companies is growth in net asset value (NAV). This is a company’s assets minus its debt. So if the business sold all its properties for market value and paid off its debts then what is left belongs to the shareholders. Whether the figure is above or below the value of the company’s share price determines if investors are paying more for or less than the company is worth.

If, for example, an investor buys a real estate business for 120p a share and its NAV is 160p a share the company is trading at a discount in that it can be bought for less than its net assets are worth.

To work out how deep the discount is take the share price away from the NAV per share figure and then divide what is left by the NAV per share figure. For example:

160p - 120p ÷ 160p x 100 = a 25% discount

To find out how large a premium is that you would have to pay to buy a company, take the NAV per share figure away from the share price and then divide by NAV per share. For example, if the NAV is 120p and the current price is 160p then investors would have to pay 33.3% more for the business than it is worth.

160p – 120p ÷ 120p x 100 = a 33.3% premium

Picking a winner

To improve the chances of buying a company that has the potential to grow NAV look at the quality of management, how many years’ experience do they have in the property market? Then look at strategy. A company that buys an asset and then improves its value through refurbishment or altering its use, such as turning offices into apartments, is likely to be improving the value, and therefore the rent, of its assets.

Companies such as Palace Capital provide exposure to markets in the regions, while CLS and Workspace provide offices, housing and warehouses in London. Lok’n Store is a self-storage company, while Unite provides student housing and Grainger is a residential specialist.

Those looking for higher yields could look at a real estate investment trust, known as a REIT, which does not receive a corporation tax bill on income-related to its property income if 90% of profits are returned to shareholders as a dividend. Investors should expect to pay income tax on these returns, but shares can be held in individual savings accounts (ISAs) and self-invested personal pensions (SIPPs).

To assess value, apply the usual NAV tests but also look at dividend yield. You are after all choosing a REIT over a mainstream property company because of the potentially higher returns it offers. Care home owner Target Healthcare offers a 5.8% yield, according to SharePad.

There are some big companies available in the REIT universe. Offices and shopping centre developers British Land and Land Securities, the companies behind the Cheesegrater and the Walkie Talkie in the City, are REITs.

REITs’ performance

Source: Thomson Reuters Datastream

Funds

Another alternative is to buy a property-focused fund, which owns shares in real estate companies and could give exposure to overseas markets.

Top performing UK-focused property funds over five years

Fund	5 Yr anlsd %
Scottish Widows HIFML UK Property 2 Acc	7.94%
Henderson UK Property OEIC I Acc Net	7.72%
Henderson UK Property OEIC I Inc Net	7.68%
Legal and General UK Property Feeder Fund I Incom	7.56%
Legal and General UK Property Fund I Accumulation	7.55%
Legal and General UK Property Feeder Fund I Accumulation	7.54%
Legal and General UK Property Fund I Income	7.50%
Scottish Widows HIFML UK Property 1 Acc	7.44%
Aberdeen Property Trust B Net Acc	6.88%
Aberdeen Property Trust B Net Inc	6.80%

Source: AJ Bell YouInvest

As always, DO YOUR RESEARCH. Look at a fund’s top holdings, which industries do they invest in? Is there a chance that demand in those sectors could decline? What is the geographic spread? What is the investment objective? And does it, and the managers, have a strong track record?

There are many ways investors can add bricks and mortar to their portfolios, so avenues are riskier than others and the returns can vary from product to product. Doing your homework and deciding what you want to achieve before you start could help you avoid any costly problems.