Investing in real estate in the UK is a popular method for investors to diversify their portfolio across a different asset class than stocks and bonds. But there are multiple different approaches to go about doing it. And each has its own advantages and disadvantages.
What is real estate investing?
Real estate investing, or property investing, is the practice of purchasing real estate with the intention of growing wealth rather than personal comfort. But there isn’t a strict rule stating the two can’t overlap. And the most common type of real estate investment in the United Kingdom is a mortgage on a family home.
What’s more, investors aren’t restricted to just residential property. Thanks to the introduction of modern financial instruments, individuals can tap into opportunities in industrial and commercial property as well, such as warehouses, parking lots, hospitals, retail parks, and even just plain old land.
In 2022, the UK real estate market has been a strong performer versus the stock market. In fact, property prices, on average, have risen by 5.6% in the first six months of 2022, owing to increased demand in the post-pandemic period.
There is brewing concern surrounding a house price reversal in 2023 and 2024. But some analysts remain optimistic, predicting another 9% growth before the end of the year.
With that in mind, let’s explore the five best ways to invest in real estate assets.
5 ways to start investing in real estate in the UK
Here I have listed the five best ways to start investing in real estate:
1. Real Estate Investment Trust (REIT)
A real estate investment trust is a publically traded company listed on the stock market that takes shareholder capital, buys real estate, and rents them to consumers or businesses.
In the United Kingdom, REITs are listed on the London Stock Exchange. However, these are not standard businesses.
The REIT status grants them immunity to corporation tax. However, they must also pay out 90% of taxable earnings to shareholders via dividends. This makes them popular amongst income investors. Learn More.
2. Real Estate Funds
These are essentially mutual funds that invest exclusively in real estate-related securities like REITs. Their property asset portfolio is typically more diversified. And prospective investors can choose between passive or actively managed property funds.
The latter employs an investment manager to oversee the portfolio and attempt to outperform a benchmark index such as the FTSE 350 Supersector Real Estate.
3. Buy to Let
Instead of buying financial securities, an investor could purchase a house directly using a mortgage to rent it out. The rental income is then used to cover the mortgage payments with a little extra profit each month.
4. House Flipping
An investor takes out a mortgage to purchase a property that is typically run down for a reasonable price. Upon purchase, they invest capital in renovating the distressed property as quickly as possible before reselling it at a higher price. The difference between the buying and selling price minus renovation costs is equal to the profit.
5. Real Estate Crowd Funding
This is a relatively new method of investing in real estate. Property developers connect with investors to fund large projects in exchange for a small piece of equity. Once the project is completed and sold, investors receive a stake in the profits proportionate to the amount they invested.
Pros and cons of investing in real estate in the UK
Property is often considered to be a safe long-term investment. But there have been multiple times when the opposite was true.
Like everything in the world of finance, investing in real estate has advantages and disadvantages. The UK housing market has been quite favourable for property investors in recent years. But with government support schemes ending and rising interest rates, things might be going south again. At least in the short term.
With that in mind, let’s look at some of the pros and cons of investing in this space.
|Growing demand for real estate typically causes property prices to rise over the long term.||Some real estate investment options, like house flipping and crowdfunding, can take a long time to pay off.|
|High property prices in the UK have made long-term rental properties more popular, creating additional opportunities for Buy To Let investors.||Landlords must find and deal with tenants, which can occasionally be problematic. If they fail to pay rent on time, and the investor depends on this income to meet their mortgage payments, it can create severe problems with the bank.|
|It can be a reliable source of passive income requiring little effort when investing via a REIT or real estate fund.||Buying property directly is expensive, often requiring a loan from the bank in the form of a mortgage. However, if the value of the property declines, it’s possible to have a mortgage that’s larger than the value of the property.|
Investing in real estate vs stocks
There’s a common battle about which investing strategy is better – stocks or real estate.
The historical performance has been mixed, with one outperforming the other for prolonged periods. This makes it difficult to discern which option is best for building long-term wealth.
However, nothing is preventing an investor from exploring both investing avenues at the same time. So, let’s look at some of the main differences.
|Considerably higher control as investors get to choose the location and quality of the asset they’re buying.||Very little control, with investors essentially entrusting the management team to make the best decisions.|
|Fluctuations in the property market don’t affect rental cash flow until after a contract has expired. (Providing the tenant continues to pay their rent on time).||Business cash flow can become compromised, resulting in a cut or suspension of dividends, adversely impacting any passive income received.|
|Low liquidity – Real estate can take weeks or even months to sell.||High liquidity – stocks can be bought and sold within seconds.|
|Requires a large amount of upfront capital to invest in property.||Investors don’t require large sums of capital to buy shares in the stock market.|
The bottom line
Real estate investing in the UK can be quite intimidating. Similar to stocks, there are a lot of factors to consider before committing to an investment.
The best approach to use when investing in real estate ultimately depends on personal preference and time horizon.
Due to their high level of liquidity, buying shares in a REIT or real estate fund may be more suitable for a property investor operating on a short-term time horizon.
Similarly, investors seeking a more hands-on approach with a longer time horizon may find Buy to Let, House Flipping, and Crowdfunding more appealing.
Another aspect of property investing that needs to be considered is taxes. Profits made on selling real estate are subject to capital gains tax. Similarly, any income generated from a rental property is subject to income tax. Furthermore, stamp duty land tax needs to be paid when buying a property. And to top things off, inheritance tax may also enter the picture later down the line.
Using a Stocks and Shares ISA to invest in real estate securities like a REIT or property funds can help shelter gains from the tax man. However, there are few protections available for investors buying real estate directly.
Regardless, each strategy has its risks. But when executed correctly, they offer an additional method for investors to diversify their portfolios as well as build wealth over time.
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Saima Naveed does not own shares in any of the companies mentioned in this article. The Money Cog has no position in any of the companies mentioned. Views expressed on the companies and assets mentioned in this article are those of the writer and therefore may differ from the opinions of analysts in The Money Cog Premium services.