Investing in real estate, alongside bonds, cash and shares, is recognised as an effective way to diversify an investment portfolio and it can provide a steady, life-long income. This month we discuss different ways you can invest in property including some secure alternatives that you may not have considered before.
Direct Property Investment
The most obvious way to invest in property is directly. Direct real estate investment offers steady income generation through rental yields alongside the potential for capital appreciation, thus helping to maximise returns. Furthermore, mortgage providers may be willing to lend you some of the money you need to make a purchase, this could help improve your returns. However, direct real estate investment is not risk-free: the property could remain vacant for long periods; there is a risk that property goes down in value (capital depreciation); having a loan may prove expensive if there is no income from the property; and overall returns from direct property investment may not be high. Further, it requires a large amount of time and capital to create a diversified property portfolio and this says nothing of the time and expense required to manage and maintain the property.
Investing in property through a collective investment scheme, where one’s capital is invested alongside others’, can help resolve some of the issues associated with direct investment. They provide diversification – removing the concentration risk associated with a small property portfolio. It may allow exposure to larger commercial properties that would otherwise be beyond the reach of individual investors and this can create better returns when economic times are good. A property fund should also come with professional managers to spare you the time and effort of managing the property yourself, albeit for a fee (and these can be high). There are pitfalls though – investing at the wrong point in an economic cycle may create capital losses; there is a potentially higher risk from properties with underlying problems if there is a concentration risk; funds invested in property are less likely to have liquidity in an economic downturn; and property funds often have very significant leverage from lenders with onerous covenants that banks may call upon and impact the funds’ performance.
An often overlooked way of investing in property is through debt. Advantages of this method may include an attractive risk/return profile as:
- debt provides a predictable stream of interest payments
- capital security can be provided by taking security over the borrower’s property
- lenders rank first when a property is sold
However, returns are not always what they seem – so you should look closely at risk-reward. Here are some examples:
Your savings in the bank are often used to lend on property indirectly (as banks lending to people and businesses often secure debt on the property, with other debt unsecured) the disadvantage is relatively low returns, the advantage is that banks are regulated and for small investors, there are compensation schemes if a bank were to go bust. The compensation schemes won’t necessarily guarantee all of your capital.
Since the financial crisis, a number of new lenders have emerged, some are referred to as Peer to Peer Lenders, where one person lends another money sometimes secured against property – these opportunities come in all shapes and sizes and crucially not all carry the same level of risk or return. Typically where higher returns are promised there is also a much higher level of risk to your capital, either because of the underlying quality of loans (which may be unsecured), type of property used for security, or the profile of the borrower.
Another way to invest in debt is through a fund structure. This is likely to have a significant advantage over Peer to Peer lending because a fund should offer diversification alongside other benefits of investing in debt and reduce some of the risks
Here are some of the areas to consider if you are investing in debt:
Consumer loans - often used to fund the purchase of mobile phones, washing machines, and other goods sold through retailers, give little worthwhile security to the lenders/investors because the underlying goods are typically worth significantly less second hand. This sort of debt can be high risk but often comes with higher headline returns.
Development loans - lending to property developers, who often start with demolition of an existing property before building something new and seeking new buyers, can be much riskier than lending against finished property.
Property types used as security - Lending against retail shop premises may be a higher risk than lending against a residential property particularly with a shift to online shopping and economic uncertainty.
Higher loan to property value lending - for example lending 75% of a property value will be much riskier than lending 50% of the property value.
RAW Capital Partners has a debt fund that only invests in residential property loans, secured on residential property in the UK and the Channel Islands and averaging less than 50% of the property’s valuation. It provides a very consistent return to investors. Our expert team use a robust credit process and specialise in identifying quality, low-risk lending opportunities. The RAW Mortgage Fund launched over four years ago and investor capital is now spread over more than 180 loans secured on different properties. Shareholders and directors of RAW Capital Partners are significant investors in the Fund, so every time we lend a pound, our capital is at risk alongside investors, and our interests are aligned.