I have always been a fan of owning property, it’s very much a British thing. We love owning and talking a lot about property.
In fact, how much our houses go up in value is a common conversation point, more so than how much we earn through salaries!
Since buying my first flat in London in 2002, I have owned a number of UK properties, four flats and one house in total. Every one of them have been my primary residence at the time and lived in them for at least 1-2 years. None of the them were purchased with the aim of them making any rental return.
Mostly from luck than judgement, all but one of the properties (ironically the only one purchased outside of London!) made very good returns when I sold them. This is especially the case for the last place we owned where prices shot up due to Crossrail station being a few hundred metres away.
Recently my wife and I discussed buying UK rental properties in the UK again. That was until I caught up with a finance guy who has just moved to Malaysia to live/retire who suggested an alternative. He mentioned looking at Real Estate Investment Trusts (REITS) as an option to owning property without the headache of managing them. So, a truly passive property investment that would be much easier for us and potentially a lot more profitable.
I thought it would be good to compare the benefits of buying UK rental property in the current market versus what seems like an attractive alternative in the form of REITS. The end of this post I will be making a decision as to which investment looks more promising. Which one will I go for?
Why Do I Want to Invest in UK Property?
Good question, especially as not long ago I was so keen to sell my London house.
Well the main reasons are for diversification and supplemental income. I should also admit I quite like the feeling of owning something substantial, something that can be touched. Although the flip side to this is having to maintain and manage it, which is something I discuss later on.
I am not a great investor by any means and as my monthly investment updates sometimes show.
I am bit old school regarding investments in that for over 20 years my aim was to own at least two properties outright in the UK and be able to live off the rental income in SE Asia.
Best UK Buy-to-Let Rental Yields
Recently I considered buying a UK property in Bournemouth, but this decision was mostly emotional and not necessarily based on sound economics.
My family is from Bournemouth and live there, and so there could be advantages to having people on the ground, so to speak.
But the question I really should be asking is where in the UK attracts the best rental yields?
For a quick check on the best UK rental yields I used the UK Buy-to-let Yield Map from totallymoney.co.uk.
What is clear with a quick glance of this map is how much yields vary in parts of the UK. Even within London the yields can vary significantly!
I was surprised to find Bournemouth was in the worse performing for buy-to-let yields! Under 3%.
With London the buy-to-let yield tends to be lower and property prices a lot higher, but the market is very robust. I have also ALWAYS made significant profit (in the 25% plus range) in terms of capital gains when selling London property!
Some of the best buy-to-let areas in Britain in 2018 were Nottingham (11.9%), Liverpool (9.79%), Cleveland (9.45%), Bradford (8%), Leeds (7.43%) and Manchester (7%).
There are plenty of websites that advertise property to buy/sell and for rent, and so you can check out the types of property and approximate prices on the likes of https://www.rightmove.co.uk and https://www.zoopla.co.uk.
Cost of Buying Property in the UK
I thought it would be helpful, certainly for us before making a decision, would be to break down the costs of a hypothetical purchase and rental of a one-bedroom property in Bournemouth.
This way I can analyse the TRUE COST of buying a property and renting it out, along with the potential upside with rental returns.
Of course, this is going to be using estimated figures for a one-bedroom flat in Bournemouth.
Purchase Costs[table id=13 /]
* I have not put any figures here associated to buying furniture for the rental property here.
Rental Costs[table id=14 /]
* Estimated the monthly service charge fee and ground rent according to figures found on rightmove.co.uk. Real estate management fees from previous experience with talking with Bournemouth agent.
Gross and Net Yield Calculations[table id=15 /]
* These figures do not take into consideration factors like building maintenance, increases in service charges or to periods between tenants.
Remember: These calculations are very much estimates and based on a number of assumptions. Another factor for consideration are the UK Tax liabilities of UK rental income, which could mean paying 20% of the profit. In addition, over the long-term buy-to-let property prices should appreciate and so upon selling would be subject to capital gains tax.
UK Rental Property Rules
In recent years the laws on UK property rental have changed significantly, so much so its led to some saying the UK government have been anti-landlords.
The tax-savings have certainly changed, and now you cannot offset your mortgage payments against your rental income like before.
Council tax also has to be paid on the property even if it’s empty. This is a real consideration, as if you’re not renting it out it’s going to cost you!
Yearly gas and electric certificates to ensure the property adheres to basis safety standards.
Before renting out the property an energy performance certificate (EPC) is also required. These should be done when buying the property and so shouldn’t be an additional expense.
And talking about safety, you need to ensure there are working smoke alarms, furniture met minimum safety standards, and that electrical devices are safe.
How to Buy UK Property, Yourself or via a Limited Company?
There are usually more benefits to setting up a limited company when compared to being a sole trader when doing business in the UK. Although the benefits have reduced in recent years (such as tax-free dividends up to a certain value being the main one), but the rules concerning landlords and buying and selling UK property have changed too.
When I met an accountant a few months ago to discuss the possibility of buying UK property to let out, he recommended owning under my name instead of going for the limited company route.
The pros and cons of buying personally or setting up a limited company for your property portfolio is out of the scope of this article. So, I would check out the following resources on this and ultimately have a chat with your accountant or tax advisor.
Limited Company or Personal Resources
Will Brexit Affect the UK Property Market?
Most people have heard the biggest fiasco to happen in the UK in the last few years, yes that’s right Brexit.
Leaving politics aside here as I don’t want to go down that rabbit hole. The point here is the impact of the exchange rate and property prices.
The effect on the exchange rate between the pound sterling and the main currencies is clear, in most cases a 10-15% drop in the GBP value. There has been a noticeable effect on property prices too.
This was to be expected as there is just so much uncertainty as to what is happening.
But has Brexit dampened UK house prices or are they remaining stable?
On my recent trip to London a few months back I met with the owner of the estate agent who sold our house. Discussing London house prices and it seems similar properties to ours are 10-15% less now – this is a significant drop!
This of course could be a nice buying opportunity for anyone with the cash and bullish outlook on the UK. For me, I am really unsure how the next few years are going to fare in the UK.
Real Estate Investment Trusts (REITS)
Real estate investment trusts (REITs) make it possible to reap all the benefits of owning property while adopting a hands-off approach.
REITs are listed companies that use investors’ money to buy real-estate that are then rented out to tenants. The majority of profit from rental income is used to distribute to investors.
Similar to owning physical property investors can also benefit from capital gain as the property portfolio increases.
The most appealing aspect of REITs for me is the healthy dividend yield. But just because a REIT provides a good dividend yield it may not be a good investment.
REITs can be a good way to diversify investments as they tend to less volatile than stocks. They also tend to fluctuate less with maximum drawdowns of 20% from its base price unless of course we’re in the midst of a global finance crisis, like in 2008.
Holding REITs to realise a future profit from selling them can take longer than traditional stock as there tend to be less dynamic.
Types of REITs
There are different types of REITs with some companies owning a basket of different property types.
- Industrial REITs: Industrial REITs focus on industrial related properties such as warehouses, industrial parks or even data center.
- Commercial REITs: Commercial REITs emphasize on office buildings.
- Residential REITs: Residential REITs are rather self-explanatory. They own and manages family rental apartment buildings and build houses.
- Hospitality REITs: Hospitality REITs focuses on properties the hospitality side of the business, owning properties such as serviced apartments and hotels.
- Healthcare REITs: Given our high medical inflation, health care REITs will be an interesting one. Mainly focusing on investing in hospitals, medical centres, nursing and retirement homes.
- Retail REITs: Retail REITs invest in shopping malls and freestanding retail.
There are pros and cons to owning different types of REITs that can depend on the market conditions and can be country specific.
Best Place to Buy REITs?
You can buy publicly traded REITs in most stock exchanges around the world, which makes it a straight forward way to have an International property play.
There are International REITs that concentrate on owning property in the best countries for investment in terms of political, legal and economic climate.
There are also REIT ETFs that look to own a number of REIT investments in different countries and industries.
Singapore is a popular location for REITs as it’s become the second largest REIT market in Asia with over 40 listings in the Singapore stock market.
Buying REITs in Singapore is very advantageous too from a tax perspective as none the dividend distributions are taxed! This means it’s an excellent option for anyone looking to spread their risk and follow the flag theory of global living.
Cost of Buying REITs
Just like traditional stocks there is a transaction cost associated with buying REITs. These vary from broker to broker and so cannot comment for others but Saxo Bank for example charge 0.05% and Interactive Broker charges around 0.08% of the trade value.
So, the cost of buying REITs is incredibly low when comparing owning real estate yourself. There are no maintenance issues to factor in also.
Average Return of Investing in REITs
This really does depend on the REIT purchased and of course how the market is doing.
If you have bought REITs just after the financial crises of 2008 and held until recently you will have done very nicely. Some REITs have shown a 100% return in share price on top of annual dividends of between 5-8%!
Over the last 20-years commercial REITs (9.5%) have outperformed the S&P 500 Index (8.6%) by around 1 percent (Source). This doesn’t take into account that many REITs provide a higher dividend distribution than traditional stocks.
This suggests at face-value that REITs can perform well over the long-term if a buy and hold strategy is the aim.
Of course, this is not an indication of future performance.
How to Buy REITs?
The same with traditional stocks, REITs are traded on the stock exchange, so you can buy them using most online broker accounts.
Pros and Cons of Investing in REITs
Like any investment vehicle, there are both advantages and disadvantages when looking to invest in REITs. Here are main ones that I consider important.
Pros of REIT Investments
- REITS must pay out 90% of their income as dividends
- REITS are very liquid assets more than real estate investments
- REITS provide passive income with chance of capital appreciation
- Own real estate without hassle associated with real estate investing
- Access to global real estate investments
Cons of REIT Investments
- Not all REITs are good investment plays
- Share prices can drop when property values fall
- Rising interest rates can hurt profits and therefore dividend yield
- Low occupancy rates and increasing vacancies hurt revenues
- Sometimes dividend tax can be high depending on the jurisdiction
Why I Personally Like REITS
I like the fact that by owning REITs you can receive a consistent passive income. This is what I have been striving towards in the 20-years working and earning money online, but instead of having an online business I will use money from these businesses to invest.
In contrast to buy-to-let properties that require hands on management, REITs are completely passive once you have researched and purchased them.
As I am based in Asia, I am keen to look at investment opportunities here and Singapore looks to be a great option (thanks Reza for the heads up here).
Some great resources on Singapore REITs
Verdict: UK Rental Property or REITS?
This article has looked into the state of the UK market, approximate buy-to-let yields and the logistics of managing it. I compared an alternative property play of buying REITs, a much more passive option with the ability to buy into any market.
Taking a look at REITS really opened my eyes at the potential for earning a dividend income to either reinvest or use as supplementary income.
Of course, REITS aren’t without their problems especially if you choose the wrong one, but on balance the pros outweigh the cons.
Comparing the figures used in this article it seems that REITs could outperform in terms of potential yearly income with dividend yields depending on where in the UK you owned property. Some REITs return double the average yield of many UK property rents (especially in Bournemouth and many parts of London)!
So, for the time being I am going to avoid buying a UK rental property and research more into REITs and look to incorporate them into my financial strategy. In a future post I will discuss some of the REITs I have been researching, so watch this space.