Investing in property or real estate in the UK is a popular method to build wealth. In fact, as of October 2022, the Official Rental Income Statistics revealed that there are an estimated 2.74 million landlords in the UK alone.1 And it’s not difficult to understand why.
According to real estate services company Savills, the residential rental market in the UK is expected to grow by as much as 18.4% over the next four years.2 And with diversification playing a vital part in any investment portfolio, exploring the opportunities within the property sector may be prudent.
Different ways to invest in property
Buy-to-let is often what most real estate aficionados talk about. But there are multiple ways to invest in this space, and not all of them require taking out a mortgage. With that in mind, let’s take a look at the top four ways to invest in property in the UK.
1. Rental properties (buy-to-let)
This is one of the most popular and widely discussed methods for capitalising on the real estate sector. The concept is pretty simple. An investor takes out a mortgage, buys a property in a well-positioned location, and rents it out to tenants.
The rental income is used to pay off the mortgage with a little extra left over to pocket a small profit each month.
While buy-to-let can provide steady cash flow each month, it’s not without its headaches. Being a landlord comes with responsibilities and continuous bills for repairs. Not to mention the risk of stumbling across an uncooperative tenant that doesn’t pay rent on time.
2. Property development
Of course, it’s possible to hire a property manager to take care of all the potential headaches involved in being a landlord. The downside is that less money ends up in the investor’s pocket. That’s why many prefer property development as an alternative approach.
Property development involves taking out a mortgage, buying a dilapidated house, investing capital in refurbishing it, and then selling it for a premium above what the investor originally paid. The goal is to increase the property value enough to cover the refurbishment cost and then pocket a profit from the sale.
While property development avoids the frustrations of dealing with tenants, it’s hardly a low-effort endeavour. Refurbishing a house takes time, expertise, and money. What’s more, the longer it takes to find a buyer, the more mortgage payments and other costs start to eat into any potential profits.
3. Property stocks
Fortunately, investors have a third option – property stocks. Instead of financing and renovating properties directly, investors can just buy shares in a public property development business.
Stocks like Persimmon, Barratt Developments, and Bellway are just a few examples of some of the biggest homebuilder stocks on the London Stock Exchange.
These firms use their capital to build residential houses across the country and then sell them. They then use the proceeds from each sale to fund new developments and reward shareholders through dividends.
An investor can buy shares in a real estate investment trust (REIT) just like any other property stock. However, these investment vehicles have some key differences.
For one thing, REITs don’t pay any corporation tax in the UK. Instead, these businesses must return 90% of net rental earnings to shareholders via a dividend to retain this special tax treatment.
Please note that tax treatment depends on the individual circumstances of each client and may be subject to change in future. The content in this article is provided for information purposes only. It is not intended to be, neither does it constitute, any form of tax advice.
For real estate investors, this can be enormously beneficial. They effectively gain the benefits of owning buy-to-let properties without needing to lift a finger. That means no mortgage payments and no dealing with tenants.
Moreover, since REITs have access to millions or potentially even billions of pounds, investors can gain exposure to other real estate market segments. Instead of focusing solely on residential houses, investors can explore different types of properties such as warehouses, hospitals, retail parks, wind & solar farms, self-storage facilities, etc.
However, just like any investment, there are risks to consider. REITs often carry large debt burdens because the bulk of capital is redistributed. This can become problematic in an economic downturn.
If businesses start falling behind on their rent, the dividend from a REIT will suffer. In extreme cases, the leveraged balance sheet could start forming cracks resulting in significant losses from a decline in share price.
Pros of investing in real estate
Investing in real estate provides investors with numerous advantages. Some of the biggest include:
- Long-term gains: The real estate sector has historically delivered similar gains to the average returns of the FTSE 100 while often being less volatile. There’s no guarantee that this performance will continue in the future. However, given the continued demand for housing, as the population grows, investors have plenty of long-term potential to capitalise on.
- Recurring cash flow: Rental income provides a steady stream of predictable cash flow. This gives investors passive income to help build wealth or cover living expenses.
- Inflation hedge: Over long time periods, property values rise in line with inflation. Therefore, investing in real estate allows investors to protect their wealth from the devaluation of a domestic currency.
- Portfolio diversification: The property sector behaves differently from the common stock market. It is also often more resilient in times of economic volatility.
Cons of investing in real estate
Just like any investment, real estate is not risk-free. There are several drawbacks of venturing into this market space that investors must consider before making any investment decision.
- Uncooperative tenants: Investing in buy-to-let properties requires constant effort. And a poorly selected tenant can be immensely troublesome, especially if they fall behind on their rent.
- Requires expertise: Buy-to-let investors and property developers both require some expertise when deciding which property to buy. A poorly selected house could severely undercut the potential returns and could even result in a loss.
- High cost: Buying a property requires a lot of initial capital that’s typically secured through a mortgage. Even investors using property stocks and REITs are indirectly exposed to this capital requirement. A large pile of debt can be particularly problematic during periods of rising interest rates and can have a substantial impact on profits.
- Illiquidity: The real estate industry operates in long cycles. There are often prolonged periods where buyers are hard to come by, resulting in falling house prices. As such, property investors of all kinds are exposed to liquidity risk.
How much do you need to invest in property?
The starting capital required to invest in real estate ultimately depends on the investment vehicle. An investor seeking to capitalise on this market segment through property stocks and REITs can begin with as little as £100. Thanks to the innovation of commission-free stock trading, it may even be possible to start with less.
However, for those seeking a more direct approach, starting capital required could be anywhere upward of £50,000. The cost could be even higher for individuals with relatively low incomes, as mortgage lenders will restrict the total amount that can be borrowed and offer less attractive interest rates.
Is investing in property right for you?
Investing in real estate can often be a smart capital allocation decision. But it’s not suitable for every investor.
Despite having a reputation for stability and being a “good investment”, real estate can perform very poorly as a result of bad timing. Remember, the property market operates in cycles that can be difficult to predict. And buying near the peak can quickly land investors in hot water.
However, for investors comfortable with the risks involved, investing in property in the UK can be an excellent method to establish a steady stream of passive income.