Tuesday, 5 March 2013

A Buy-to-Let Income Without Being a Landlord

'Property Isas' offer investors exposure to the housing market.

Should you be looking to invest in property with your Isa allowance this year?

Investors now have a broader range of funds to choose from, and for the first time can invest in the residential property market.

Up until now, most property investments have had to be via a commercial property fund. These either invest directly in bricks and mortar, though some will instead hold shares or property companies.
However, there are now specialist tax structures called property authorised investment funds (PAIFs), and real estate investment trusts (Reits) – basically a property investment trust which is listed on the stock market.

These are essentially pooled funds that can invest in both commercial and residential property. Investments held within these structures don't have to pay corporate tax on their income or gains, potentially boosting returns for investors. These can either be bought direct, or many now can be purchased via an Isa, protecting investors from capital gains and reducing the tax due on any income received.

The T M Hearthstone UK Residential Property fund is one of two residential property options now available to Isa investors, and was launched in July 2012 as a property authorised investment fund.

It invests in homes of varying sizes nationwide, and aims to provide a simpler and less expensive way of tapping into the UK residential property market than a buy-to-let.

The other option (which is not a PAIF) is Castle Trust's HouSA, launched in October 2012. This tracks the Halifax house price index and can pay a fixed quarterly income, regardless of performance.

Darius McDermott, the managing director of Chelsea Financial Services, the investment broker, said these products provide more diversification than buy-to-let by not being dependent on any one location.

He said: "The HouSA is illiquid, so if you go into a 10-year tranche and your circumstances change you can't guarantee to get your money out. It's not for everyone and we are broadly positive on it. With the Hearthstone fund, we like the fact that there is no gearing, as it buys properties outright, but the charges aren't cheap."

Nevertheless, many advisers are reluctant to recommend residential property to clients who are already heavily exposed to it through home ownership. Most favour commercial property, highlighting its ability to pay an attractive income and pointing to historically low correlations with equities and bonds.

Duncan Owen, head of property funds at Schroders, said, "Average commercial property prices as a whole fell by 44pc between 2007 and 2009, but previous to that the biggest fall on record in any one year was 14pc. In every five-year period apart from one it has given you a total annual return of 8pc to 9pc, with around three quarters of this coming from income."

But the income levels paid out by funds investing directly in commercial property are far lower than these advertised rental yields. For example, the Aviva Investors Property Trust currently only yields 3pc – although this will increase by 0.7pc when it converts to a PAIF later this year; while the M & G Property Portfolio still only yields 3.4pc, despite having converted to a PAIF this January. The differential reflects far more than just management fees.

Peter Toogood, investment director at Morningstar, said: "Direct commercial property funds need to maintain cash levels of 15pc to 20pc to fund redemptions. Reits can have marginally higher yields of 4pc to 5pc."

Because Reits are shares listed on the stock exchange, there is a good argument for investing in them via a fund that holds a range of property shares, rather than directly. Brian Dennehy, managing director of Dennehy Weller & Co, the financial adviser, never recommends individual Reits as he feels they are slightly too specialist.

He said: "We don't see any need to narrow the focus, so we prefer funds that can buy both Reits and other property shares. Because these are linked to the stock market, they operate in very different cycles to direct commercial property funds, which are very slow moving but far less volatile."

Property share funds, although not providing the same diversification from equities, have tended to outperform direct commercial property funds over most time periods during the past decade. For example, according to Morningstar, the Aberdeen Property Share fund has produced a total return of 26pc over one year and of 78pc over 10 years compared with respective returns of -0.3pc and 22pc from the Aviva Investors Property Trust.

But supporters of direct commercial property funds argue that this largely reflects the recent upturn in equities and that, because direct property tends to move a couple of years after the stock market and has now bottomed out, this could be a good time to buy.

However, some experts do not regard property of any sort as the answer for those seeking diversification. Hargreaves Lansdown is not currently recommending any commercial or residential property funds. It feels that strategic bond funds can produce a better overall return and provide some diversification from equities.

By opting for three spaniels – Tilly , Bumble and Ruby – Phil Morse has showed less appetite for diversification with his pets than with his investments.

Mr Morse, 49, who works as an investment consultant and lives near Portsmouth with his wife, Lorraine, invested £5,000 in the T M Hearthstone UK Residential Property fund in an Isa in February and will invest a further £5,000 in it during the next tax year.

He said: “It is providing me with diversification from other investments I have in equities and bonds and, although I own my own home, that doesn’t pay me an income. I intend to draw on this fund as part of my retirement planning.

“I’ve always thought of getting involved with buy-to-let but never really wanted the hassle, and this fund gives you similar exposure without being a landlord.”

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