A Primer For Investment In Homes For Reward
Introduction – Why Would You Do It?
In this piece, we take a look at investment in residential real estate from the perspective of the private investor – someone looking to become the owner of a home, or homes, for reward.
That criterion – that the investment is for the purposes of making money – necessarily excludes from the ambit of this commentary the notion of buying a home for self-occupancy. That’s not to say that money can’t be made from buying and owning your own home. Primarily though, the decision to buy an own-use dwelling is driven by the need for shelter of greater or lesser degree of comfort rather than to generate an economic gain. It’s first and foremost an emotional rather than an economic decision. As Adam Smith observed in ‘The Wealth of Nations’, over two centuries ago, “a dwelling-house, as such, contributes nothing to the revenue of its inhabitants.”
Prospective investors in residential real estate need to be clear in their objective. Is the financial outlay intended to generate income, ie, rent, or a gain in value of the property on resale, or both? We proceed on the footing that, while both income and capital gain may be hoped for, a rational investment in residential property should be based exclusively on an assessment of income potential. A gain on resale may be realised – even after inflation and capital gains tax are accommodated – but it cannot provide the rationale for the investment in the first place. The ‘flipping’ of residential properties is not investment, it’s gambling – the gamble being that there’s always someone willing to pay more than you have. And anyway these days flipping – typically seen as a resale within six months of purchase – is much frowned-on by banks and building societies, they being the folks with the money to lend on property investment projects.
A third main point is that, in the purchase of residential – indeed any – real estate, what investors gain in the security of owning ‘bricks and mortar’, they trade in liquidity. The properly registered ownership of real property is a highly secure investment – due allowance being made for possible destruction (which of course can be insured against) – but unlike most other investment assets real estate may not easily or readily be liquidated quickly should a pressing need arise.
Finally, and again as a point of distinction with other investment products, a direct investment in real estate – especially residential – is hands-on. Or else there is a significant cost in getting someone else to do the work – of maintenance and refurbishment, of letting in all its time-consuming aspects from tenant selection to rent collection, of paying outgoings, and so on. Real estate is not like shares or bonds or gold certificates which can, in effect, sit in a drawer. It has to be looked after.
It’s a given that any new business venture should, before irreversible steps are taken, be subject to a SWOT analysis. Investment in residential property is unquestionably a business venture so let’s take a quick look at how it measures up using this tried-and-true analytical tool.
Everyone needs a home and many of us can’t afford to buy one, or choose not to. There is always a housing market, including rental housing.
And houses are popular with governments, of whatever political stripe. Their ownership by the private sector – whether for owner occupancy or tenanted – satisfies a state obligation which the state doesn’t have to pay for. So there’s a low risk of adverse governmental measures.Housing is an open and transparent market, for which a huge amount of information is available, most of it for free, on turnover, pricing and trends.
To borrow from the Bard, residential real estate is subject to the slings and arrows of outrageous fortune – especially of the wider economic variety.
It’s so with any investment product of course but with property economic downtimes can put a real cost on that lack of liquidity we mentioned earlier. There’s more likelihood of being stuck with an unmovable immovable than with a Footsie in a falling market.
Legwork pays off. Given the wealth of available market information, with residential property resourceful investors can turn research and reconnaissance into investment gold. It’s not guaranteed of course, but intimate knowledge of the real estate market of choice can provide a real edge when it comes to picking prime investments.
And it doesn’t have to be inside knowledge of an upcoming deal in WC1. That run-down but readily refurbishable 1930s home a 10-minute bus ride from the University of Bristol, being sold off-market by a deceased estate, may become highly remunerative student let.
Viewed in general terms, it’s hard to see threats in the residential property market. Housing has no natural competitors, won’t be rendered obsolete, and can’t be substituted with something cheaper.
What To Look For
When looking to buy residential property to let, possibly the worst thing the investor can do is imagine him or herself living there. Because that’s when much-needed objectivity flies out the window.
Rather, the investor needs to ask – and firmly answer – the question, who is my ideal tenant? At that point the search can be launched for the ideal property. A search which should stay on the straight and narrow; the investor needs to become resistant to the advice and entreaties of every estate agent, and the appeal of every dinky little do-up, encountered along the way.
And anyway, assuming an urban location, there’s likely to be a good selection of residential property which will generate reliable and enduring rental income from the tenants of choice. The key of course is location – proximity to the places frequented by your ideal tenant/s. It could be a university, as previously mentioned, or desirable schools, or a business park or a mall – or ideally all of them! But first and foremost, your target tenants will want to live there.
And of course they should want to live in your rental rather than another in the vicinity and in the same rent range. Because yours has appealing features not offered by the competition. It might be the appealing décor, the unmarked whiteware, or the off-street parking for something larger than a mobility scooter. These are factors within the investor’s control when choosing and presenting the property.
Financing Fun and Games
For many aspiring buy to let investors, a mortgage loan will be prerequisite in getting into the market. It’s here that the property investment market intersects with the mortgage market. In financing terms, buy to let has had its ups and downs over the years – flavour of the month one moment, investment pariah the next. Yet unquestionably fortunes have been made on its back. Perhaps most famously in recent times by the brothers Candy, who reputedly embarked on their road to riches with a one-bedroom do-up in Earls Court.Reputedly, the Candy boys used a loan from their gran for that portentous first purchase. For most buy to let investors though, it’ll be down the High Street, in a bank or building society. Where, on the one hand, there is a bewildering array of mortgage products on the market and, on the other, the devil’s own job getting one.
Since the GFC – the global financial crisis – kicked in nearly five years ago, mainstream mortgage lenders have given a whole new dimension to the words ‘risk averse’. Long gone are the days of 100 percent financing, or even 90 – nowadays for buy-to-let it’s more like 60. And there are a host of barriers and exclusions thrust in the path of the would-be BTL borrower.
By way of illustration, The Mortgage Works – owned by Nationwide Building Society – won’t accept applications for BTL mortgage loans –
- With more than two applicants;
- From companies;
- From property developers;
- From non-UK residents;
- From UK residents who lived abroad in the previous three years;
- From first-time applicants who don’t own their own home;
- For remortgaging within six months of purchase;
- For the purchase of one or more of multiple (ie, two or more) self-contained units under a single title.
- Where the applicant wants to live in the property.
And even if you can navigate these waters, you’ll need to establish by an approved valuation that the gross rental from the property will be 125 percent or more of the loan interest payments, rising to 150 percent if the property is multiple-occupancy.
Investment in a holiday home is something of an oxymoron. The idea, surely, with buying a property which someone else will pay to occupy is that such state of affairs will be continuous, week in and week out, year after year. Of course, the most desirable city let may occasionally find itself tenant-less but even the most desirable holiday property will likely be vacant for months at a time.
That’s the nature of the beast – there are few places in the world which attract holiday-makers year round. Whether it be a summer or winter locale, the peak season in most tourist areas is three months at best, with the other nine being of more or less uncertain character when it comes to occupancy. No-one in their right mind would consider that prospect with a conventional buy to let, so why would you do it with a holiday home?
Is there nonetheless a case today for considering an investment in an income-producing holiday property? Perhaps, for example, because these days two-bedroom seaside apartments are going for an absolute steal in many places. That consideration, we suggest, is a diversion from rational thought. By all means, buy that fire-sale Costa del apartment from the underwater vendors trying to keep their home in Birmingham but only as a place to go with the kids over the summer. As your vendors have already discovered, it’s not a real estate investment. It’s a capital-intensive, immovable toy.
Home or Away?
Is the grass greener across the ditch? We can’t escape the conclusion that, as with holiday homes though for different reasons, an investment in residential real estate abroad isn’t first and foremost an investment. It’s an ego trip.
Applying our SWOT analysis, a major strength in residential property is enduring demand and a major opportunity is to learn where that demand is greatest and buy accordingly. But for those factors to be optimally exploited, there’s that other consideration mentioned earlier. Residential property investment needs to be hands-on.
With the best will in the world, an investor in Leamington Spa can’t be hands-on with a rental property in Las Vegas or Reno – two cities hard hit by the bursting of the American property bubble and with large numbers of foreclosed homes still being shifted onto sluggish markets. Buying such a property at a substantial discount – say 25 percent – to market is only the first step in a successful investment. That gain will quickly be eradicated if poor letting management results in troublesome tenants, degradation of the property and – ultimately – its vacancy.Of course, you can pay someone to do the legwork for you – at from 10 to 20 percent of the gross rent. But, cost aside, will an agency ever bring an owner’s commitment to the tasks of rental property management? Perhaps – but it’s something of a lottery whether you can find the agent who really will be your eyes and ears a continent away.
The investment property bought close to home may cost more than its equivalent abroad, and the returns on paper may not look so attractive. But sound investment calls for risk reduction as far as possible. Long-distance investment involves more risk than investment in one’s back yard. The upside will need to be considerable.
Suits you, sir – Or does it?
You might by now be thinking – is property investment really for me? It’s a highly pertinent question to ask of oneself. Running a buy to let investment is not for everyone. Property investors don’t have the convenience of a dividend cheque every six months or a daily – more frequently if desired – tracking of the worth of their investment on Reuters or Bloomberg. The actual worth of the property won’t be known with any certainty until it’s sold. The revenue stream will last only so long as it’s tenanted, and this will never be a foregone conclusion – the investor-owner has to make it happen and keep happening.
It’s no shame to conclude that property investment isn’t your thing. There are plenty of alternatives out there, most of which are a great deal more passive.
Which brings us before closing to passive investment in real estate. Which, primarily, means the purchase of a shareholding in a REIT – a real estate investment trust. There are of course other forms of pooled property investments but by and large they are closed to public investment and largely illiquid.
REITs, long a feature of American property investment, entered the UK market in 2007. Their primary business – not less than 75 percent in turnover and asset value – must by law be investment in rental properties, either commercial or residential, as distinct from property development or trading. They must be listed – a rule which this year was relaxed to allow listing on secondary exchanges, such as the LSE’s AIM exchange – and they must pay out 90 percent of net rental income annually. Crucially, such income is tax exempt on receipt by the REIT – tax is paid by shareholders according to their individual tax status.Currently there are some 24 REITs in the UK, including two in the FTSE 100 (British Land Company (LON: BLND) and Land Securities Group (LON: LAND)). Not all invest in residential property: pertinent information on each UK-REIT and its investments can be found on the website of REITA, maintained by the British Property Federation, at http://www.bpf.org.uk/en/reita/
From the private investor viewpoint, the main attraction of a REIT investment is its liquidity, compared with direct property purchase or participation in a private syndicate. The other side of that coin is, of course, the exposure of that investment’s value to market volatility. As listed companies, REITs are as susceptible to shifts in market sentiment as any other listed security.
REITs and their newly-emerging close relatives – property approved investment funds, or PAIFs, which are also exchange-tradable – aren’t therefore real estate investments, they’re equity stakes with exposure to the real estate market. A detailed look at them is for another commentary.