Letting investments build over time

Traditionally the second best performing asset class over time has been property. In our continuing week-long series, Dominic Coyle looks at the highs and lows of investing in residential and commercial property

Residential  property investment has one big thing going for it: in a world of financial jargon and impenetrable small print, everyone thinks they know what's involved in letting a house.

But it's not as easy as it would seem, especially the first time out. That hasn't deterred many taking advantage of the rolling back in last year's Budget of the Bacon clampdown on property investors. "There are a lot of people out there with spare cash and good incomes, who feel they should do something with it," says Sarah Wellband, associate director of Rea Mortgages. "They see equities as dodgy just now and, by keeping money in cash, they are just losing out to inflation."

Getting mortgages on second and further properties is becoming easier all the time. Many lenders will charge no premium, provided the loan being sought is for no more than 80 per cent of the property, with the balance comprising either a cash deposit or a cross security on the investor's own home.

Interest-only mortgages have also become available and can be useful in the early years.

Business has been brisk this year, now that interest on such mortgages can again be discounted from rental income before calculating tax liability. The fall in stamp duty has also helped, although there has been a slight drop-off in recent months as economic conditions soured.

So what should people consider when deciding to invest in residential property? First off is location, and it is important to remember that what makes a perfect location for owner-occupiers is not always ideal for renting.

Investors also need to be reasonable in their expectations, allowing a contingency fund of anything from three to six months' mortgage payments to cover fallow periods. When assessing your ability to pay off a mortgage on an investment property, lenders routinely knock 20 to 25 per cent off your rental estimate to reflect such downtime.

"Another major problem for first-timers is the way they look at a property," says Simon Shirley. "Many view it as if it is somewhere they will be living. It's an investment, and what they need to consider is can they rent it and will it appreciate as an investment? Don't get sentimental."

Don't try to kid your insurer. If it's a rental property, let them know. It might cost more, but at least you'll be covered.

Letting agents can be a good idea, and not just for the novice. They will generally take an inventory and find and vet tenants for you in return for the first month's rent of the let.

A tour with a letting agent can be very instructive. They will often give you tips about renting out property and a look at the sort of homes they handle and how they are furnished.

Management agents are different. They will take care of the property, ensuring any maintenance and repairs are carried out. But they don't come cheap, charging anywhere from 10 to 15 per cent of the rent plus VAT. The general advice appears to be to stay clear of them unless you have no time or inclination to deal with problems as they arise. If you are doing the job yourself, make sure you have to hand a list of tradesmen who are reliable and prompt.

Finally, remember that property investment is not a "get rich quick" scheme, despite some of the soaring rents and dramatic rises in house prices of the late 1990s. "You want to look at a minimum investment period of five years," says Shirley.

"Keep a business head," says Wellband. "Do that, and you will find that property is certainly as good as any other investment."

Commercial Property

Low interest rates and healthy yields have made commercial property investment by private individuals attractive in recent years. "There is a large appetite at the moment for commercial property," says John Moran, investment director of Jones Lang LaSalle, "and most of it is driven by private investors."

For most, entry to the market is by an indirect route through pension fund investment, unit-linked property funds or syndicates.

"Commercial property is a much more complex market than the residential market," says Simon Shirley, a personal wealth manager with BDO Simpson Xavier. "To invest in it directly, you need the necessary expertise and experience and a fair degree of cash."

Property funds are a simple affordable entry point to the commercial property market. A number of financial institutions offer property funds, normally as unitised investments. These are pooled funds in which investors buy one or more units. The advantage is that it allows the investor to take a share in the sort of portfolio that would never be open to them on an individual basis.

Portfolio investing's main advantage is that it spreads risk. If one deal goes sour, it cannot wipe out your savings.

There are some factors to take into account when looking at such funds. The first is to ascertain the fund's focus - some might invest both at home and abroad, others are more selective; some might put all their money into, say, retail properties, while others spread the risk among the other commercial classes - office and industrial/warehouse, or even hotels. You want to know what the strategy is before committing your money.

A second issue is cost. Property funds can be more expensive than other unitised investments. They have higher costs to bear.

Syndicate investing has come into its own in recent years, facilitating greater investment in commercial property.

"Essentially, syndicate buying is a leveraged purchase," says Moran. "If you are talking about buying a property worth around €10 million, between €7 and €8 million will be borrowed. Syndicate members will then put up the rest from their own resources."

Syndicates are put together by a range of people - commercial property agents, accountants, stockbrokers and banks - for a fee, usually a percentage of the value of the property. The deals tend to be for sums of €10 million or more, and syndicates, in general, are limited to a maximum of 20 people.

Basically, if you have 20 people investing in a €10 million property, each is getting a five per cent stake worth €500,000. Because of the leveraged nature of syndicated deals, most of the money, say 70 per cent, is borrowed. That means the individual investors only put up €150,000, or 30 per cent of the value of the stake. However, they are each getting a return on the full five per cent.

BDO Simpson Xavier expects annual returns of 12 to 20 per cent after capital gains tax on the investments it puts together for clients over the five to 10-year life of the investment.

So what should people look out for when dipping a toe into commercial property? Top of the list, not surprisingly, is location. Other crucial factors are the length of lease the tenant has on the building (the longer the better) and the strength of the tenant (are they established and able to pay the rent or will they fold and leave you in a jam?). The age and general condition of the building comes into it, too.

Aspiring investors need to consider whether they have a balanced investment portfolio. What access do they require to their funds? Once you put money into something like a syndicate, it is locked in there for the period of the investment - generally somewhere between five and 10 years. This includes the income from rent, which goes to pay costs and service bank debt.

Apart from location, lease and tenant, it is worth considering fixed interest rates, which lock in your exposure over the term.

Finally, loans taken out should be on a "full non-recourse basis". This protects individuals' other assets from a calamitous fall in the value of a syndicated asset and ensures the lender can take only your investment in the particular venture without recourse to your home or other investments.

At least if things do go wrong with the commercial property, you won't lose your shirt on the investment.