Property

Property is the most important of the 'alternative investments'. In many cases it acts as an asset class in its own right. For most private individuals their home is effectively a direct investment in residential property, which will frequently be worth more than all of their other investment assets put together.

Property investment is primarily divided into two basic forms:

direct investment: the actual purchase of property; and
indirect investment: the purchase of one or more types of financial instrument, where some of the underlying investment is property, e.g.
shares in property companies;
property based life funds and investment shares/units;
with-profits funds (which often have a proportion of direct or indirect property investment);
Enterprise Zone Trusts (EZTs) – a form of tax exempt unit linked investment in property).

Direct property investment

Direct property investment is often made with the assistance of a loan or mortgage, which can be an advantage or a disadvantage:

When property prices rise faster than the interest rates payable on the loan, the effect is to 'gear up' the returns and some individuals have used this method to amass large property portfolios in a short time when economic conditions are right.
When property prices fall, or interest rates are high, the 'gearing up' effect works in reverse and it is possible to lose substantial sums. In many cases the mortgage or loan (plus unpaid interest if applicable) becomes a large percentage of the value of the property and it is even possible for the situation to switch to a 'negative equity situation', where the loan is greater than the value of the property.

Direct property holdings tend to be split into two main types:

residential property; and
commercial property.

Both types of property have their own advantages and disadvantages:

Residential property typically holds its capital value as it is in great demand as most people wish to own their own home. Rents can provide a proportion of the investment return, but by far the biggest element of return is the increase in capital value. Residential property prices can also fall, especially where prices have been chased higher and higher in a desperate rush to benefit from the increase in overall prices. Such large sustained increases are often followed by a period of ‘re-alignment’, where the value of the property is re-assessed against its value as a home or its rental income stream.

Buy-to-let arrangements are often used as a way to allow private investors access to this type of investment. A homeowner selling their house would generally not benefit from a useable investment return, unless the property being sold is not replaced, or where a smaller property is being purchased to replace the former home.

Commercial property is typically purchased for its rental income and has a rather different set of investment issues than residential property:

Commercial mortgages work in a different way to residential ones and it is harder to raise a high percentage of the value of the property.
Capital values are subject to a number of different influences including:
location;
planning regulations;
communications (transport);
expansion or contraction of the local community;
the supply and demand for commercial property locally;
the terms and conditions of the current rental agreement;
whether the building is occupied or not (occupied property has a higher value than empty property, the opposite is true with residential).
The cost of a commercial building will often be higher than a residential property and, with loans harder to come by, it is a less popular asset for private individuals to own.

Both of the above types of property are expensive to buy, own and run, putting them out of the reach of the majority of private investors. The investment itself is somewhat illiquid in that realizing the capital value of a property will Lake months (if not years) to achieve. Nonetheless, property is a useful asset as the values do not correlate with the other major asset classes and, in fact, commercial and residential property values do not even correlate with each other. This makes them useful as part of a diverse portfolio. For most private individuals, with the exception of their own home, this will take the form of an indirect property investment through shares, units, life assurance or even pension funds.

Property is not a risk free asset as many people seem to think, but it is true that property prices tend to be less volatile than equities. This is because there is often a rental income stream and the factors that affect property prices (such as interest rates) tend to move in a slow and largely predictable manner. The main risks in buying property as an investment are where price realignments happen quickly or interest rates change significantly. Property as an illiquid asset can take time to sell and may fall in value continuously during this time (possibly building up interest charges) until a buyer is found.

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