Investment Property, is one of the major asset classes usually included in a portfolio, along with bonds and equities. It is attractive because it provides an inflation hedge at a moderate risk level. This means that as prices of goods and services go up, the price of property also tends to go up. Equities provide inflation hedges too, but at much higher levels of risk. So, very roughly speaking, one can look at investment property as being somewhere in between bonds and shares in terms of risks and returns. But most importantly, we all depend on property. We all have homes, offices, and so on. This means that we are all vulnerable to some degree to increases in the cost of property, so it makes sense to offset that with investments in it. It also means that an investment property, as a source of income, is not as likely to fail or become obsolete as some do.
On the other hand, one of the major disadvantages of investing in property, historically, was the need to invest large sums in a single physical investment property. However, over the past decades, an ecosystem of funds, trusts and companies has arisen that allows you to invest in property in a diversified way and without the hassle of managing the relationship with tenants yourself.
For those looking to learn more about how to invest in property, we have answered some common questions below.
Investment Property – Where to invest? And what to invest in?
Sometimes best place to invest is somewhere you know or live. Apart from financing and tax issues which can be tricky, property investment is often quite common-sensical. For example, you probably know whether your neighbourhood is on the rise, if a certain residential area looks nice at first glance but is noisy at night, and that some retail locations tend to thrive while others seem to be complete lemons. You might even have heard that Mr. X is looking to sell quickly. All of this information improves your chances of making a good investment as compared to investing at a distance. This is especially important if you are investing in physical property rather than in shares of real estate funds, trusts or companies, as physical investments are less liquid and can represent a large percentage of your total net worth. On the other hand, focusing your property investment close to home may not be ideal in terms of diversification – with adequate advice it may then make sense to venture further away.
As with other kinds of investment, risk and return go hand in hand. Prime office real estate at the heart of a major city such as London or New York is likely to preserve its value over the long term. As the rents from these properties are relatively ‘safe’, they are often low as compared to the price of the property, even though they may be eye-watering in absolute terms. So investing in very prime real estate carries relatively low risk, with moderate returns. On the other hand, a plot of land in a speculative beach resort venture in a faraway island in Thailand may, if successful, offer very high returns as compared to the initial investment, but also carries much more risk.
Some of the main factors affecting investment property risk are:
- Location – the country, city, neighbourhood and street on which the property is all affect not only the price of the real estate, but also its risk.
- Market conditions, especially vacancy rates – if market conditions are deteriorating and vacancy rates are rising, the likelihood of your property being affected increases.
- Stage of development – you can invest in real estate at any stage of its development, from a project that is currently just a plot of land, to a building that is ready but yet to be leased, to a fully-leased ‘performing’ asset. The earlier the stage of development the higher the risk.
Are property prices high or low?
The key follow-up question here is “as compared to what?”. Investors typically compare property prices to history, other locations, rents and personal incomes or retail sales:
- History – see how prices have changed over a long period of time. In some cases prices may be high as compared to a few years ago, but more reasonable if you consider a longer history – if a country is emerging from a crisis, for example. Bear in mind that real estate prices can rise or fall for many years, so you should consider this indicator together with the others.
- Other locations – compare prices to those in similar locations. It is important to be pragmatic in your comparisons. For example, if residential prices in London were much higher than similar space in New York, Paris and Tokyo, or if apartments are much cheaper in one neighbourhood than in another equally prestigious one, that would be interesting to note. Comparing real estate in larger or wealthier cities or prime locations to that in smaller or poorer cities or less premium locations is less useful.
- Rents – you can compare the rental yield (the rents divided by the price of the property) to bond yields to understand how these investments compare financially. The difference here is that properties can increase or fall in value, according to inflation and other factors. If rental yields are much lower than bond yields, you know that you have to assume that property prices will increase, because of inflation or otherwise, for the investment to be advantageous vs. bonds.
- Incomes and Sales – how much a person can pay in rent depends on how much they make, and rents and property prices are linked. So property prices should be linked to incomes and sales in a region. For instance, The Guardian reports that median house prices were 4.4x yearly income in London in 1995, but had risen to 12.2x by 2013.
How do I go about making an investment property?
You can contact real estate brokers directly, talk to financial firms specialising in property investment or seek assistance from an independant financial advisor. Property brokers can show you a range of physical properties and get you up to speed on local rules and standard contract terms, but are appropriate if you have a clear idea of what you are looking to buy. Investment firms can provide a range of physical or financial real estate investments, but again, are most appropriate if you have an idea of what you want. A financial advisor can assist you in suggesting the best kind of property investment given your overall financial plans and risk profile.