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Property


What is it?

Property, sometimes called 'real estate', refers to 'bricks and mortar' such as homes, offices, shops, factories, hotels and also land.

The attraction of property to some investors is that, unlike shares, they can see and touch it, i.e. it's a 'real' asset. However, it's usually harder to buy and sell than shares, making it less 'liquid'.

Although most of us simply try to buy our own home and leave it at that, some investors buy property with a view to developing it for profit and/or renting it out. A decade of soaring property prices from the mid 1990's created a boom in property investment, particularly investors who bought houses to rent out (often using borrowed money), known as 'buy to let'. Some burned their fingers as property prices fell back down to earth, reminding us all that there's no such thing as a 'dead cert' in the investment world.


Ways to get a return

There's two ways to earn a return on property. An increase in the property's value and/or rental income.

Property PriceRental Income

If you can sell a property for more than you paid for it, you'll make a profit. If you're lucky, the price might simply rise due to a buoyant property market. Some investors prefer to seek profit by developing a property. This could mean buying a run-down property and renovating it, or perhaps buying land and seeking planning permission to build a residential or commercial building.

Don't forget to factor in the costs of buying and selling. Buying costs include stamp duty, surveying and legal fees. Selling costs include estate agent and legal fees. These costs could all add up to around 3% - 7% of the property's value. Use our Property Buying Costs Calculator to get a clearer idea of the overall costs of buying a property.

What types are there?

Property really falls into two categories, residential and commercial. Holiday homes are technically residential but as there are additional factors to consider we'll treat them as a separate category.

ResidentialCommercialHoliday Homes

This is property where someone can live. If you own, or are buying, the home you live in then this is technically an investment, and chances are it's the biggest you'll ever make.

Some investors buy property to rent out, which has created a large rental market. However, if you borrow money to buy a rental property you could struggle to make a profit from rent alone, especially after deducting running costs. Most investors therefore rely on rising house prices for an investment return, unfortunately prices tend to be more erratic than rents.

The UK residential property market has generally boomed over the last 30 years, but there's been some steep downturns along the way. It's certainly not the one-way bet that some had seemingly started to believe!

What's going to happen to house prices?

Well, let's be honest, no-one knows for sure. The credit crunch has taken its toll, but given the extent rising house prices had outpaced earnings you might feel that a downturn was inevitable anyway, take a look at the chart below.

There's no doubt that the cost of borrowing, i.e. interest rates, plays a role. If mortgage rates are low you can afford to borrow more money, as can everyone else, fuelling demand for property and pushing up prices. However, if there's an economic downturn and you lose your job, then low interest rates make little difference if you lose your home through having no income to pay your mortgage.

Three sensible ways to improve your chances of making a profit are:

  1. Buy a property that requires some renovation/building work at a rock bottom price. However, tread very carefully and accurately estimate the building costs.
  2. Buy a property that is very marketable (e.g. great location, size, features etc.) as this will increase your chances of selling in a stagnant market.
  3. Buy in an area that has a strong rental demand. A consistent rental income will help stabilise your investment return.

What costs can I expect?

The following are typical (ignoring any mortgage related costs):

Buying Selling Running
Item Typical Cost Item Typical Cost Item Typical Annual Cost
Stamp Duty 0 - 5% of purchase price Estate Agent 1% - 3% of sale price Letting/Management Agent 10% - 15% of annual rent
Surveyor £250 - £1,000+ Legal / Conveyancing £250 - £500+ Property Maintenance 10% of annual rent
Legal / Conveyancing £250 - £500+ Service Charges
(if a flat)
0.25% - 1% of property value
Land Registry £40 - £700 Building Insurance (if not covered by a service charge) £150 - £300+
Gas safety certificate £50+
Estimate for £200,000 property / £10,000 annual rent £2,850 £4,350 £3,250

If the property is vacant between tenants then you may be liable for council tax.

Find out how much profit and yield your investment property is generating using our Property Rental Yield Calculator.

How is it different from residential property?

As an investor there are several key differences:

  • Commercial buildings tend to be larger, hence more costly to buy, than residential.
  • Rental agreements are usually much longer than residential, typically 10 years or more.
  • Commercial property can take much longer to sell than residential.
  • Tenants are normally responsible for all insurance, maintenance and repairs.
  • Most of the investment return is likely to come from rent, not rising property prices.
  • Rent is normally charged at a rate per square foot or metre.

What types are there?


OfficeRetailIndustrialLeisure

These can range from a single room to a huge multinational company headquarters and business parks. Office space can be used for many types of business, so provided it's in a good location it can be easier to find tenants than retail or industrial space. Nonetheless, it's not immune from an economic slump. In bad times companies maximise use of existing office space and cut jobs, both reducing demand.

What is rental growth and yield compression?

If you ever talk to a commercial property professional you'll almost always hear the words 'rental growth' and 'yield compression' mentioned.

Rental growth refers to the extent a property owner can increase the rental income they receive. This might happen by increasing a tenant's rent, renting out previously vacant space or redeveloping sites that can be rented to new tenant's for more money.

Yield compression refers to a fall in rental yields, most likely due to a rise in property prices. Suppose commercial property yields 10% while gilts only yield 5%. Investors might flock to commercial property seeking this attractive yield. However, the increased demand for property will push up prices, which in turn reduces (i.e. compresses) the rental income yield.

Is it a good idea?

If you're buying property overseas purely as an investment and have little intention of ever spending time there, either now or in future, then I'd seriously think twice before doing so.

You'll have to delegate day to day management to someone else many miles away, which can often lead to problems, and currency movements could affect your investment.

If you plan to spend time in the property, perhaps even retire there, then the personal benefit and pleasure you'll get from it could help make the investment risks more worthwhile.

What things should I consider?

If you do decide to buy then think about the following points (amongst many others) before you take the plunge:

  • Does the property market rely on foreign investors rather than locals? If so, you might struggle to find a buyer if the area/country falls out of favour with foreigners.
  • If the property requires building work/renovation, get several quotes and ensure there are no hidden extras. Builders could be hard to manage if you're based in another country.
  • Ensure you get good, honest, legal advice. Foreign property laws often vary from those in the UK and falling foul of them could cost you a lot of money, or even your property.
  • If you buy off-plan, never hand over instalments without viewing (ideally yourself or someone you trust) the construction progress of your property.
  • Never feel pressured into buying by persuasive salespeople. They're probably on a fat commission and couldn't care less whether the property actually meets your requirements.
  • If you're planning to rent the property then check out the local market. What rents do similar properties achieve and what are typical occupancy rates? Also factor in the costs of renting.
  • You'll probably need to pay income tax on any rental income back in the UK. Check whether you'll be liable for any local tax and whether this can be offset against UK tax due.
  • The notion of owning your own holiday home can seem idyllic, but in practice it could be a lot of hassle and do you really want to holiday in the same place for the next 20+ years?
  • How easy is it to get to the property? If it's more than a couple of hours from an airport you might find it restricts rental opportunities.
  • Don't buy a property just because it's cheap. You've got to enjoy visiting and staying there - if you don't then chances are potential renters won't either.
  • Get a breakdown of all purchasing costs, including local taxes, legal fess and agent commissions (in some countries both the buyer and seller pay commissions).
  • Don't believe agents who tell you the property is a great investment. Do you own homework and analysis.
  • If you plan to retire to the property what would it really be like living there? Living in the area full-time could be very different to a two week holiday.
  • Use a currency exchange service to get the best deals when buying local currency to make the purchase.
  • You may need to take out a Will in the country where the property is based to safeguard your interests.
  • Make sure the property is properly insured.
  • Beware timeshare properties, the industry is full of unscrupulous salesmen.

Tax

Unless the property is your main residence, you'll almost certainly end up paying tax on it at some point.

Residential Commercial Overseas
Income Tax Yes, on rental income Yes, on rental income Yes, on rental income*
Capital Gains Tax Yes, unless the property is your main residence Yes Yes*
Stamp Duty Yes Yes No, but local taxes may apply.
* Unless you're non UK tax resident. You might also be liable to tax in the country where the property is based.

How can I buy property?

If buying property as an investment, your first decision should be whether to buy a physical property or invest via a fund. Funds offer the benefit of a low initial investment, reduce risk by spreading your money across many properties and usually allow you to sell simply and quickly. However, most property funds invest in commercial property, with options for residential property being very limited. You'll also have to pay fees to the fund manager, reducing your potential return.

Physical Property

When buying physical property, you'll need to decide whether to buy direct from an owner, via and agent or at auction. The property might already exist, or may not yet be built (known as 'off-plan') The property may also be owned as 'freehold' or 'leasehold'.

Direct from OwnerEstate AgentAuctionOffplanFreeholdLeasehold

The Internet has made it far simpler for property owners and developers to advertise their properties direct to potential buyers. The attraction for them is cutting out estate agents and their commissions. As a buyer there's less benefit unless you can get a good deal on the property due to the seller saving on agent commissions, or you're buying in a country where buyers pay agent commissions too. The main reason for buying direct is simply that the property you like is being sold this way.

Property Funds

There are several types of popular property funds:

Unit TrustsREITsPensions

Almost all property unit trusts invest in commercial property, either in the UK and/or overseas. This might be through buying physical property, shares in property companies or a mix of the two. While a convenient option, bear in mind you may incur an initial 'spread' (effectively a charge) of up to c5% to cover the costs of buying property (stamp duty, agent and legal fees). But, provided there's a buyer the fund group can pass your units on to when you sell (rather than cancel the units), the costs incurred in buying property will usually be transferred to the new buyer. However, if there's more sellers than buyers then expect to bear the brunt of the property purchase costs and in extreme circumstances for the manager to suspend dealing while they sell some properties to fund the redemptions.

When a fund invests the shares of property companies (including REITs) the volatility and correlation to stock markets is likely to be higher than physical property.

Find out more about unit trusts here.


Property jargon

Click below to display some of the more common property jargon:

JargonMeaning
ChainA succession of buyers and sellers who are reliant upon one another to complete buying or selling properties. A delay on one will have a knock on effect along the chain.
Commercial PropertyProperty from where someone can run a business, e.g. offices, shops and factories.
ConveyacingThe legal process for transferring ownership of a property from the seller to the buyer.
DeedsLegal documents proving ownership of the property.
FreeholdWhen you have absolute ownership of a plot of land and all buildings on it.
Land RegistryA government office responsible for recording the ownership of land.
LandlordSomeone who owns a property and rents it to a tenant.
LeaseholdYou own the property for the duration of a lease, after which it reverts to the freeholder.
OffplanCommitting to buy a new-build property before it's completed.
Property Stamp DutyA tax levied when purchasing a property.
Real EstateAnother word for property.
REITReal Estate Investment Trust, a type of investment company that invests primarily in property.
Rental YieldThe amount of annual rent received from a property divided by its value.
Residential PropertyProperty where someone can live, e.g. a house.
TenantSomeone who rents a property from a landlord.
Yield CompressionRefers to falling rental income yields on commercial property. Usually caused by rising property values.