3rd September 2016 at 7:30am
Every investment is different. Each one has different features, pros and cons and, of course, varying potential for growth involving a trade-off between risk and reward, among other things.
It got me thinking: what makes an ideal investment?
Well, aside from delivering a decent return (of course), my kind of investment would be:
Easy to trade: To buy and sell when I want
Divisible: Can be sold bit by bit, rather than all at once
Tax efficient: Takes advantage of tax breaks, or at least isn’t penalised by additional tax
Easy to value: If you don’t know how much it’s worth how can you tell how it’s doing?
Low cost: Buying, selling and maintenance costs are low.
What about property?
Several of my friends are property investors, although they probably wouldn’t describe themselves as such. And I’m thinking buy-to-let here.
People invest in property for different reasons. Many have a fundamental belief in property prices rising over the long term, having seen their own home rise in value, or cite the shortage of housing and healthy demand.
Others become accidental property investors, for example when a couple each own their own homes and subsequently move in together, renting out the other; or someone inherits a property.
For many, there is that sense of a tangibly ‘solid’ investment they can see and touch; property is undoubtedly one of the most tangible forms of investment.
But tangible doesn’t necessarily equate to solid.
What are the downsides of property investing?
The problem is that property investing has a number of hidden downsides we tend to neglect.
For a start, buy-to-let property can be riskier than you might think. People often gear the investment in that they borrow money to fund the purchase with a buy-to-let mortgage. The result is they need to generate enough gains after tax and expenses to cover the mortgage, just to break even.
Buy-to-let property can be riskier than you might think
Then there’s the issue of only being able to buy and sell as a whole. It’s hard to sell half a flat if you only need half the money, want to reduce your exposure or need to access some capital.
And while it’s easy to buy and sell when the market is buoyant, property markets have a tendency to slow up just when you want to sell. Then it’s not like selling stock market shares when you can almost always find a buyer; you might not find a buyer at all, at least not without lowering the price very considerably and waiting a very long time. And you might be left without the funds to fully repay that interest-only mortgage.
What about valuing the property?
Property prices can only be guessed at, with professional estimates coming at a cost until the asset is actually sold. You can’t look up the price precisely; you just have to take a fair guess at it. Some might say this gives an illusion of stability, so we can think property prices are more stable than they actually are, just because we don’t know what the value really is.
You can’t look up the price precisely; you just have to take a fair guess at it.
Consider transaction costs and taxes
Aside from solicitors and agents fees, which can be considerable, property can incur significant taxes.
While many investments can be held within mainstream tax-efficient accounts like pensions or ISAs, your typical residential buy-to-let can’t.
Property can incur significant taxes.
So rental profits are taxed at your marginal rate and capital gains taxed at 28% for higher rate taxpayers, and 18% for basic-rate taxpayers. You can, of course, offset gains against the annual £11,100 capital gains tax allowance, but on a typical £200,000 property this is only 5-6%.
But it doesn’t have to be either or, as our article on deciding between pensions or buy-to-let highlights.
Recent property tax changes
Recent changes have shifted the taxation stance of property from neutral to, arguably, more penal through:
- Increased capital gains tax rates – capital gains are taxed at only 10% or 20% for non-residential property, compared to up to 28% on rental properties
- Removal of the ability to offset mortgage interest on rental profits – meaning you pay more tax on rental income if you’re funding it with a mortgage
- A 3% stamp duty surcharge for second homes – so it now costs more to buy a new property
The recent tax changes have possibly done most to dampen the enthusiasm for some buy-to-let investors but the other challenges could be just as off putting.
You can read more about capital taxes in our article on why capital taxes needn’t be taxing.
Creating a balanced investment portfolio
But it’s not all doom and gloom, it’s fair to say. It’s clear property can have a role to play in a balanced investment portfolio and returns can be good for those who buy based on a solid business case and spend the time going through the figures before they do.
Drifting into property investment isn’t a solid strategy given the financial exposure many already have through their main home. Plus, property can go up and down like a roller coaster and can be particularly vulnerable when downturns hit or bubbles burst.
To look at it rationally means taking a hard, cool look at whether it’s a good option, and works – crucially – as part of a balanced portfolio you build to meet your goals and give you the returns you’re looking for.
Property can go up and down like a roller coaster
Me, I’m sticking with my pensions, ISA and shares. They might sound less exciting to some people, but I’m more convinced they’ll give me the long-term return I need.
The views expressed here are those of Andy Dunbar and should not be regarded as financial advice, or the views of Standard Life.