Real estate has long been touted as one of the safest investments anyone can make. Notwithstanding the ups and downs of the property market, and the various tax and regulatory matters to consider, it can indeed be very rewarding to invest in UK property. Speak to anyone who has built up even a moderately impressive property portfolio, and they are likely to tell you how it has been the key to their financial freedom. However, real estate investing is not without its risks. Success in this arena depends not only on a good eye for desirable property but also on a decent working knowledge of the ins and outs of the market, the various options available, and the fundamentals regarding financing and other related matters. If you are considering making your first investments in UK property, this guide to the basic options and concepts will help you take those first steps.
Types of property investment in the UK
Property investment in the UK usually takes three forms: buy-to-let investments, property development, and refurbishment to sell or 'flipping'. Seasoned property investors may try all three at some point, and each one has its particular set of benefits and possibilities.
Buy-to-let property investments
Buy-to-let property remains a great investment, with the possibility of generating a source of ongoing passive income. There will always be people who will tell you that the days of profitable buy-to-let investing have passed, but the truth is that, regardless of current market conditions or legislative frameworks, careful buy-to-let investing can still pay off.
It can be difficult for first-time investors to get onto the property ladder. However, provided you start in a location you know well, invest according to your abilities and available resources, and exercise prudence and patience, you can become a buy-to-let property owner and hopefully see a return on your investment. Housing is always in demand, and if you can offer properties that meet the area's demand within a given price range, you're likely to have no issues finding tenants. You also need to remember that being a landlord comes with more than just a financial commitment. You need to manage and maintain your properties to keep them marketable – or hire professionals to do so on your behalf.
Buy-to-let investment is a long-term commitment and might only show decent returns after some time has passed. If you are looking for a strategy with the possibility of yielding returns in the short term, property development is a great option. Development involves finding existing properties that need work. You can then purchase them at a reasonable price, add value by renovating them and then attempt to sell them for a profit. While this can be very rewarding, you need to choose your property carefully and consider factors such as:
- The price you pay for the property vs the price you can sell it for
- How much the renovation will cost
- The time it takes to complete the refurbishment
- The current or future state of the market
Many property developers have a tendency to underestimate their costs and the amount of time it will take to get the property ready to sell. Success depends on being honest with yourself about your costs, prospects and expectations and making your decisions accordingly.
Refurbishment to sell on
Buying a property in need of refurbishment to sell it after the project is complete (known as 'flipping') is another strategy for quick returns, but it doesn't always work out as planned. The profitability of these ventures depends on your ability to sell the property for more than you paid for it. You need to have a good knowledge of the area and what the property would be worth after refurbishment and have a clear idea of the costs involved with the property purchase and sale and the refurbishment itself. It can work very well, but it can be a risky strategy. If the market should fall by the time the building is completed, or you run into higher costs than anticipated, you could be stuck with a property you can't sell, be forced to break even or even sell at a loss.
Often landlords decide to take on a property to refurbish before adding it to their portfolio of rental properties so that they can add immediate value to their investment.
If you are interested in property refurbishment, find out more about refurbishment finance here.
REITs (Real Investment Trusts)
It is also possible to make indirect investments in the property market. Real Estate Investment Trusts (REITs) buy large numbers of properties and rent them out. Anyone can invest in REITs, essentially becoming shareholders in their property portfolios and receiving dividends depending on the properties' performance. This option offers the advantage of investing in rental property without having to worry about management and maintenance. These investments come with specific tax implications, so you should always speak to a qualified tax adviser before deciding to invest.
What are the typical costs of property investment in the UK?
There is more to investing in property than simply paying the purchase price. Becoming a real estate owner involves several ongoing costs, particularly if you take the buy-to-let option. These include the following:
This is the biggest and most important ongoing expense. You will need to make payments on your mortgage every month, so make sure you have taken a mortgage that suits your budget. If you are letting the property, mortgage lenders will require your rent to cover your mortgage repayment costs and more to make sure you will be able to keep up the repayments.
Property ownership comes with so many risks, and it is absolutely vital that you have good insurance to cover any potential damages and losses. Research your insurance options carefully and factor the annual or monthly premiums into your budget.
As a landlord, you need to manage and maintain your property. Whether you decide to take on that task yourself or hire a professional property management firm, it will incur an ongoing cost. On the bright side, these costs are tax-deductible.
Rates, taxes and utilities
Being a property owner comes with a variety of expenses such as municipal services, capital gains tax, and running costs such as electricity and water.
How much capital do I need to invest in property?
While a mortgage will help you pay the majority of the purchase price of your property, giving you the chance to pay it off slowly over several years, real estate investment remains a capital-intensive venture. Although you can make the most of the credit that mortgage lenders are prepared to extend to you, you should always put up as much of your own money as you can. The more you have to put down as a deposit, the lower your mortgage costs will be in the long run. Most lenders usually require you to put down a minimum of 25% of the purchase price as a deposit. Aside from that, you should keep cash in reserve to cover your management and maintenance costs and any void periods (periods between tenants where it's not rented).
How can I find the right property to invest in?
Choosing the right property is a rather inexact science. Investors will often find themselves drawn to properties that others may advise them against purchasing. There are certain intangible factors at play relating to an investor's personal preferences or preconceived ideas about certain properties. When it comes to investing, it is important to balance your preferences with smart financial decisions and seek out good advice from property professionals and seasoned investors. Here are some things to consider as you ponder your options:
- Choose the right neighbourhood based on your budget and your expectations about potential tenants.
- Consider all the costs, not just the purchase price.
- Seek advice on which locations are most promising and whether they are most suitable as buy-to-let, property development, or refurbishment investments.
- Investigate the location around your desired property and look for any factors that might affect property values. Good schools and popular shopping venues in the vicinity will increase the desirability of properties. Rising crime rates or high levels of pollution will have the opposite effect. Don't get caught up in the property's attractions before you have a thorough understanding of the area surrounding it.
What are the Risks of property investing?
Like all investments, real estate does come with a few risks. Here are some of the most important ones to consider:
- Extended vacancies (void periods): If you own a rental property, you need to keep the void periods to a minimum. With no tenants and thus no rent being received, you are still responsible for mortgage payments and so would need to fund these from savings or other income. The longer a property is unoccupied, the more it will cost you.
- Liquidity problems: When you invest in real estate, you need to be prepared for the fact that your money will be tied up in your property for a long time. If you need to free up cash in a hurry, for whatever reason, your real estate portfolio will not be much help because it takes time to sell properties. Just be prepared that the wealth you acquire and grow through property investment will not be instantly available when you require liquidity.
- Damage and loss: Buildings are vulnerable to all sorts of damage. Fires, natural disasters, water damage from burst pipes, and vandalism are just a few of the risks you face as a property owner. These risks are relatively easy to mitigate, provided you have good insurance coverage.
Can I afford a mortgage?
Affordability is a long-term consideration when it comes to mortgages. Once you have got your mortgage, you need to be able to pay it every month for years. It is very important to consider whether you have the capacity to make such a commitment. Mortgages are available to people of all income levels, with affordability depending on the ratio between income and costs. When purchasing a property as a primary residence, the rule of thumb is that the mortgage payments (and related expenses) should amount to no more than about a third of your income (28-30% is regarded as the ideal figure). It is a little more complicated with investment properties, but in broad terms, the rent needs to cover the mortgage payments based on an assumed interest rate of 5.5%, by 140%.
Mortgages for Business is a team of award-winning mortgage brokers serving buyers in the residential, commercial, buy-to-let, and property development markets. Contact us if you are looking to invest in property in the UK and would like to know more about your finance options.
27th January 2022