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How to gain exposure to property

22 June 2017

Changes to buy-to-let tax relief, coupled with rising house prices and the introduction of a stamp duty surcharge on second homes, mean buying a property to rent out is no longer a viable option for many. We examine how to gain exposure to the property sector, without physically owning bricks and mortar.

The value of investments can fall as well as rise and you could get back less than you invest. If you’re not sure about investing, seek independent advice. o   Tax rules can change and their effects on you will depend on your individual circumstances.

What you’ll learn:

  • What tax changes are affecting buy-to-let investors.
  • The pros and cons of investing in property.
  • How to get exposure to the property market.

Buy-to-let investors have seen the introduction of a raft of changes to tax rules in recent months which make being a landlord a less attractive option for many.

Changes include a new 3% stamp duty land tax surcharge introduced in April 2016 on top of standard stamp duty rates for anyone buying a second home, along with the end of the “wear and tear” tax allowance for those letting out a furnished property.1

April this year saw the introduction of rules which will gradually restrict the amount of tax relief landlords can claim on mortgage interest. Landlords can now only offset 75% of their mortgage interest against their profits, down from 100% previously. This will fall to 50% next year, 25% in 2019 and zero in 2020. Landlords will have to pay tax on their total income, including rent, and apply to HMRC for a tax credit of 20%.2

Remember that tax rules can and do change, and their effect on you depends on your individual circumstances, which can also change.

As a result of these changes, the appetite to be a landlord appears to be waning. Latest figures from the Council of Mortgage Lenders show that buy-to-let lending was down 79.5% in March this year, compared with March 2016.3

Before adding exposure to the property sector within a portfolio, check the holdings of current investments. Many mixed-asset funds, for example, will have some exposure to this sector so if investors already hold these, they may not feel the need for specialist property funds as well.

However, there are plenty of other ways for investors to gain exposure to property without physically owning bricks and mortar.

Commercial property

Most property funds invest in commercial property, which includes offices, shops and warehouses, where yields are typically higher than in the residential market, because businesses are prepared to pay more for space in a good location that helps them achieve their goals.

Property funds were particularly popular before the financial crisis, with record inflows in 2006 at the height of the property bubble, when the economy was growing and commercial tenants were seeking space for their businesses. This boosted returns for investors with rising rental income and property values.4

The impact of Brexit on businesses remains unknown, but commercial property funds should remain well placed to deliver an income to investors. Funds in the commercial property sector include the L&G UK Property Trust and the Henderson UK Property fund.

However, there are some potential challenges ahead that could impact the commercial property sector, including the growth of online retailing, difficulties posed by economic uncertainty following the UK’s vote to leave the EU, and potential interest rate rises. Any or all of these factors could put pressure on the popularity of commercial property, and in turn yields and value.

Please note that our mentioning these funds should not be taken as a recommendation to buy or sell any particular fund. If you’re unsure, seek professional financial advice.

Global property funds

Investors looking for global exposure to property can choose funds that either purchase specific properties overseas or that invest in baskets of overseas Real Estate Investment Trusts (REITs) and listed property companies that hold a range of commercial properties, including shopping centres and office towers around the world.

Having a spread of different investments across a range of geographical regions can help reduce the risk that your portfolio value will be damaged by a fall in one particular market or area, as the hope is that some of your investments will rise to offset falls in other areas. However, remember that investing in funds or company shares that hold assets in overseas markets does expose you to foreign currency risk. This means that the value of these assets and the income that they generate can fluctuate due to differences in exchange rates.

Bear in mind of course, that volatile share prices could offset any gain or loss from currency movements.

Real Estate Investment Trusts (REITs) are investment trusts, and therefore, unlike unit trusts, they are structured as companies and listed on the stock market. Investment trusts may trade at a discount, or premium, to the value of their underlying assets, according to demand for their shares. Market movements may affect the performance of the underlying property assets, and investors may see their investments rise or fall in value.

As shares in REITs are traded like stocks, this means investors can more easily sell their holdings if they want. Open-ended funds, however, can face liquidity issues, particularly if a large number of investors want to cash in their investments at the same time. Managers without a sufficient cash buffer in place will have to sell some properties, and this often cannot be done quickly. Last year, for example, several funds were forced to temporarily suspend trading after the UK’s vote to leave the EU lead to a wave of redemption requests.5

UK residential property

In the wake of the Brexit vote, some economists feared that the UK’s housing market would suffer badly. But so far, the market has proved reasonably resilient, with house prices falling for the first time in nearly two years in March.6 The Bank of England holding interest rates at a record low of 0.25% has helped buoy the market, enabling borrowers to benefit from cheap mortgage rates.

According to Barclays UK Property Predictor, despite an uncertain political and economic climate, house prices in areas across the UK are set to rise by an average of 6.1% by 2021, bringing the average value of a UK property to almost £300,000.

Bear in mind that this prediction is based on various assumptions which might not materialise. Changes in political, tax and economic factors could produce a different result. Prices might go down. A return of 6.1% in four years is equivalent to a return of around 1.5% per annum. This might be lower than inflation, which could mean a loss in real terms.

Rental yields and valuations remain attractive to investors, and the fall in the value of sterling has increased the appeal of the UK property market to overseas investors, who can effectively buy property in prime locations such as London at a discount.

There are a handful of funds to choose from for investors seeking exposure to the UK residential market, without the time and effort involved in buy-to-let investments. These typically invest in a variety of properties, including flats, houses and bungalows in the private rental sector.

Holding a proportion in property within an investment portfolio offers some diversification away from traditional asset classes such as shares, bonds and cash. Diversification won’t take away all the risk attached to investments but it can reduce the chances of you losing all your money.

Also, remember your money is tied to the performance of the property market, and like any investment, your investment could go down as well as up, and you might not get back the original amount invested.

Given uncertainty surrounding the impact of political and other events on markets, investors should ideally remain focused on their long-term goals when investing in property or any other investment sector.

Remember that investments can fall as well as rise and you may get back less than you invested.

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