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How to invest in property without buying a house

31 October 2018

We explore ways you can invest in property, without purchasing physical 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.

What you’ll learn:

  • What the pros and cons of property investment are.
  • How to invest in property.
  • How new regulations affect property investments.

Property is one of the major asset classes, along with cash, shares and bonds.

Even if you don’t want to buy a property yourself, there are plenty of ways you can potentially profit from bricks and mortar. Here, we explain how to go about it, and why it’s important to understand the risks involved. 

Remember, that all types of investments carry risk, so if you’re considering investing in property, you must be prepared to accept that you could get back less than you put in.

Why invest in property?

Holding property within an investment portfolio can help provide diversification, as it tends to perform differently to other assets in response to different market conditions.

That means if, for example, shares are performing badly, property may perform better. The hope is that by investing in a broad spread of assets, if one area underperforms, the performance of others may compensate for this.

Find out more about diversification

The other main attraction is that property can potentially provide a good source of income thanks to rent from tenants, as well as the opportunity for capital growth if property prices rise.

Over recent years however, a series of changes to tax allowances have affected the attractiveness of becoming a landlord. In 2018 the Chancellor announced restriction to letting relief on Capital Gains Tax, which came after previous years which introduced a 3% hike in stamp duty on additional properties, and the abolition of the 10% ‘wear and tear’ tax relief on furnished homes. The amount of mortgage interest relief that can be claimed by landlords is also being gradually reduced – and is set to reach the basic rate level of 20% by April 2020.

As a result, the appeal of investing in physical bricks and mortar is waning, prompting some to consider investment products that give exposure to the property sector. These tax rules could change again in the future and their effects on you will depend on your individual circumstances. We don’t offer personal tax advice, so you might want to consider independent advice.

Many property funds invest in commercial property, such as retail parks and office blocks. Typically, yields are higher than those available from the residential market, with businesses prepared to pay more for the right location. Bear in mind that there is the risk of a commercial property standing empty for a period of time. Meanwhile, recent developments in retail with the demise of several well-known high street chains have underlined the risk of insolvency for businesses that run into financial difficulties.

Yet a handful of funds offer exposure to the UK residential market through flats and houses within the rental sector, where income yields and valuations remain attractive to investors. However, these are less common than funds that are focused on commercial property.

It’s also possible to invest in indirect property funds that instead focus on the shares of firms within the property and property development sector, rather than physical bricks and mortar. In this case, their performance is linked more closely to the wider share market and the trading performance of the firms in question as opposed to a direct link to the value of property and the income that it generates. These funds are typically not as popular as direct property funds.

If you want to search and buy property funds via Smart Investor, you first need to open an account so you can browse the full range of investments available.

Find out more about choosing funds and ways to narrow down your choices here

Understanding the risks

If you’re considering investing in a property fund, it’s important to understand the risks involved. Property is known as an ‘illiquid’ asset because generally it can be difficult to sell quickly, at its market value. Property values can, similarly to any other type of investment, fall as well as rise, and there are no guarantees you will make money.

If a large number of investors attempt to cash in at the same time, this could force some property funds to suspend trading, unless they have a significant cash buffer in place. For example, several funds were forced to temporarily suspend redemptions in 2016 after the UK’s vote to leave the EU led to a wave of redemption requests which exceeded the cash available in the fund. When this happens, it means that investors cannot sell their holdings until the suspension is lifted and the value in the meantime continues to change, possibly falling.1

Before investing in property funds, it’s important to check the holdings of any investments you might already have too. For example, if you already have a multi-asset fund, which invests in a range of different assets, this may hold investments in property, so you may decide you don’t need to add a specialist property fund to ensure your portfolio is properly balanced.

The best way to find out exactly what your existing funds invest in is to read the Key Investor Information Document (KIID), which explains the fund's key features, such as its investment objectives, where it invests and the costs involved.  You can also review the largest holdings of the fund by looking on the product page in our Fund search, and also the fund manager’s Factsheet that you should find there along with the KIID.

Remember your investment in any sector could go down as well as up, and you might not get back the original sum invested.

So what types of property funds are available?

Property funds can be structured in different ways.

Open-ended funds

Many property funds are unit trusts or open-ended investment companies (OEICs). Known as ‘collective investments’, these pool your money with that of other investors in a range of shares and investments. You are able to buy shares in OEICs, which are incorporated as a company, or units in a unit trust, which are established as a trust.

The price you pay will depend on how the fund is performing at that particular time, with the value of units or shares rising or falling depending directly on the value of the underlying assets held by the fund. In the case of investors wanting to leave and sell their holding, the fund manager will buy back units or shares.

Most property funds hold a proportion of the fund as cash so that investors can take out their money when they want to. However, if lots of investors decide they want to cash in at the same time then, as previously mentioned, this can cause real problems if there isn’t a big enough cash buffer in place and the fund needs to sell property assets to get investors their money. Many property funds have significantly increased the amount of cash they hold in an attempt to prevent a recurrence of this problem, but this can potentially damage the ability of this type of fund to generate both capital returns and income as a larger proportion of the fund is not invested as it remains as cash. Despite the increased allocation of cash, if there was a repeat of the mass redemptions seen in 2016, managers may still decide to suspend client redemptions, with investors left unable to sell their holdings until the suspension is lifted.

Find out more about how funds work

Closed-ended funds

Closed-ended funds such as investment trusts and Real Estate Investment Trusts (REITS) may also invest in the property sector. These funds are listed on the stock market, and trade like stocks and shares throughout the day. Once their particular shares are listed, investors can buy them on the market. Unlike investment trusts, a REIT can only own or finance income-generating real estate assets.

Market demand dictates an investment trust or REIT’s share price, which can move either above or below the value of the assets that it holds, called the Net Asset Value (NAV). When the price moves above the value of the fund, it's trading at a premium. When the price falls below the NAV, it's trading at a discount.

Stock market ups and downs may affect the performance of the underlying property assets, and of course, investors may see their investments rise or fall in value.

Find out more about how investment trusts work

Investment trusts don’t have the same type of liquidity issues that are associated with open-ended funds. When investors sell shares in an investment trust, the manager does not need to sell physical assets, as the investor is simply selling the shares on the market to another investor. For shares to sell, you need someone who wants to buy your shares from you. However, bear in mind that property funds such as investment trusts that are listed on the stock market can see their values fall or rise depending, amongst other things, on the performance of the underlying property assets, which will influence demand.

There are also geopolitical risks that could impact on property sector yields and values. For example, the economic uncertainty following the UK’s vote to leave the EU, and while Brexit negotiations continue. Also, any interest rate rises may place pressure on businesses’ finances within the commercial property sector.

How new regulations affect property investments

Most open-ended funds are subject to the Undertaking for the Collective Investment of Transferable Securities (UCITS) regulations, which generally cover retail funds with underlying assets that are relatively easy to price and sell. UCITs’ rules include that the fund must invest in assets that can be easily priced, sold, and must not concentrate investments in too small a number of assets.

However, open-ended funds that invest in illiquid assets such as property, are likely to be run as non-UCITs retail schemes (NURS), which follow different rules.

Find out more about non-UCITS retail schemes

You should make sure you understand the features of a NURS, investment trust, or REIT and what they mean for your investment; the new regulations mean you will now be asked to complete a quick Appropriateness Assessment before placing a purchase in any these products.

The value of your investments can fall as well as rise, and you might get back less than you initially invested. If you’re unsure where to invest, consider seeking professional financial advice. 

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