Part 2: Direct or indirect? Incorporating real estate into your investment portfolio
With its myriad investment structures, timescales, risk options, tax possibilities and management styles, real estate is a richly varied asset class – and an important element of any well-diversified portfolio.
Before deciding on a property strategy to help you meet your financial objectives, it’s worth weighing up a few considerations specific to the property market:
- First, consider your investment time horizon – the property opportunities available to you vary, depending on how long you’re able to have your cash tied up for
- How much time do you have to dedicate to your property investment? Bear in mind that some require significant management time – or an additional output in management fees, as an alternative
- Think about how you’d like to receive your returns – are you looking for a regular income or equity uplift, for example?
- Do you have a personal interest that might impact your property strategy? You might have a passion for renovations or be looking for a rental that can double as a home for your children during university
Covering both direct and indirect investment opportunities, the second instalment of our property series explores the various possibilities for international investors looking for strategies to diversify their portfolios with real estate.
Property opportunities can be categorised into direct or indirect investments
When we talk about direct opportunities, we’re referring to the buying, owning, renting, managing or selling of a property. Direct investments can deliver short-term gain – either in the form of rental income or by leveraging the fix-and-flip model (more on this below) – as well as profits over a longer period. However, they also involve significant initial capital outlay.
Conversely, indirect property investments – investing via bonds, loan notes and other platforms or vehicles – have a lower financial entry point. With indirect investments, you’re often investing alongside others and are given a repayment schedule – with capital and interest elements of your investment set out in advance.
Loan notes to deliver a fixed income
Offering exposure to residential and commercial real estate, loan notes (or corporate bonds) fund property development companies. They can be short-term, fixed-interest investments – and you’re often given a choice between receiving interest payments during the term or deferring interest until the repayment date.
- Only invest in opportunities where due diligence on the developers is robust – for example, consider opportunities from developers able to demonstrate a track record of at least 10 years
- Bear in mind that the quality of the note is dependent on the security it offers – look for loan notes that offer legal charges, debentures and security trustees to reduce the level of risk
REITs deliver the benefits of property ownership without the hassle
Much like a fund manager that invests in shares of companies, REITs (Real Estate Investment Trusts) pool funds from a large group of investors, enabling them to invest in larger-scale projects with a real estate focus.
Covering everything from hospitality to logistics and data centres, REITs allow you to invest in real estate without the hassles that normally accompany property ownership such as leases, mortgages and upkeep.
REITs fall into one of three categories:
- Equity – where an investment in real estate provides income from rent, dividends and capital gains
- Mortgage – involving an investment in mortgages and mortgage-backed securities that earns you interest that’s sensitive to interest rate changes
- Hybrid – where the investment is in both real estate and mortgages
If liquidity is a priority, consider an investment in a UK-listed company
Major house builders – Barrett Developments or Bellway PLC, for example – are listed on stock exchanges. Alternatively, you could go one step further and invest in companies that supply materials and services to the building industry.
Bear in mind that share values in some of the major developers have fallen significantly this year – with higher raw material costs and labour shortages a factor to consider. However, if you’re willing to ride out the uncertainty, the fall in share prices means you have an opportunity to buy at a price that’s below market value – and see benefits in the longer term.
Fix and flip an older property – but balance risk with potential returns
Turning to direct property investments, perhaps the best-known model for property investors is fix and flip. Though it offers the potential for high returns, it’s worth keeping the following factors in mind:
- The significant initial capital requirements – as well as payments for materials and tradesmen (which are currently high)
- The active management involved – you’ll need time and perhaps a passion for property renovations
- The risk, which is much higher than with other investments – amongst other things, you’re at the mercy of property market swings and building timelines which can get pushed out
Embrace new builds for their environmental benefits
Energy efficient and high quality, many international buyers are turning to new builds as a lower risk direct property investment.
If you’re interested in establishing a buy-to-let portfolio, new builds are an increasingly attractive prospect, as they appeal to renters looking for homes that are cheaper to run. What’s more, new builds are often available with a full turnkey management solution for international landlords – which simplifies the process of managing your property from elsewhere.
Before investing, you should familiarise yourself with the other elements involved in purchasing and renting a UK property – stamp duty and the capping of tax relief on buy-to-let properties, for example.
Invest in commercial real estate if you’re in it for the long term
Investing in hospitality or commercial property involves a large capital outlay in return for the opportunity to benefit from significant profits – but only for those prepared to wait for their returns. Alternatively, invest in a portion of the project through specialised investment companies. You could own part of a Hilton, and enjoy a certain number of nights stay as part of the package.
So how much of a property focus should your investment portfolio have?
At Lawsons Wealth, we’d recommend having a portfolio with three discrete elements (or ‘buckets’):
- A long-term bucket – with funds invested in equities and bonds to benefit from market returns over a long period
- An opportunistic pot of short-term investments and opportunities– right now, equity markets aren’t too attractive, so this could be a fixed return loan note
- Property – by kickstarting this ‘bucket’ at an early stage in your life as an investor, you can leverage existing property to buy more and develop out a portfolio
Look out for the final instalment of our property series, where we’ll consider property investment in the lifecycle of an investor. And if any of the direct or indirect investment types we’ve covered in this instalment have piqued your interest, please get in touch. Our experienced independent financial advisers will explore your options and help you navigate the diverse landscape of the property investing world.
