Residential property is a relatively easy to understand investment – you buy the property just like how Covenant Properties buys real estate in and around Louisville, and then rent it out to provide a regular income, whilst also having the prospect of capital growth. It’s an attractive option for investors for several reasons: it is tangible; has a relatively strong track record; provides a hedge against inflation; has low correlation with mainstream assets and the right property can achieve steady long-term returns. The benefits are almost endless, but a lack of appropriate knowledge and due diligence can cause difficulties.

Current Market Outlook

Since the economic downturn in 2008 mortgages have been more difficult to come by (although Government support including help-to-buy has helped to reignite the market over the last 12 months). A large number of owners decided to rent out their homes to help cover mortgage payments and many have been unable to move up the ladder due to rising house prices (5.3% price increase since February 2013) and a lack of wage increases.

Currently 16.5% of all households in England rent the property they currently live in – growth in “generation rent” is expected to continue. Savills estimates that the private rental sector in the UK is will grow by one million households over the next five years.

While it is typical for rents to keep up with inflation, it has recently been reported that the London rental market has failed to do so, and in some cases has fallen significantly short. Total UK inflation from 2005 to 2013 was 30.5%, while the average London rent only increased by 11.4%.

Returns

Prime city centre properties like champions gate villas for rent often report higher returns and tend to have a lower risk of remaining vacant, as the demand for housing is greater (although these properties can be the most expensive). According to Zoopla.co.uk, the average annual rental yield in the UK is currently 5.1% – and in certain key areas is as high as 8.9%. While housing prices remain high, price rises are predicted to slow in the coming years. This will have an effect on returns as more people shift to buying rather than renting. The Royal Institution of Chartered Surveyors (Rics) forecasts average rental yields will drop to 4.82% by 2018.

Considerations

There are several things to consider when looking for a residential property investment. Location and management need to be thought out carefully. The location of the property is notably most important. There are a number of opportunities to invest abroad, but this requires extensive research and investors may be put off by a lack of knowledge of the markets and laws in foreign locations – investors should also note that just because the market as a whole in that country may be performing strongly, there could be very large regional variations in performance (as seen in the UK market). Understanding the local market is key.

Management of a rental property can be very demanding. Engaging a management company to handle the many aspects of letting the property is likely to be an attractive option, but this comes with extra costs. What impact could this have on returns?

Tax considerations

The impact of taxes on profits also needs to be considered. A UK based investor would be subject to income tax on rental income at the band as they would for normal employment income. The good news is that taxes are taken after costs, and there are several costs that investors can claim for. Capital gains tax on investment properties in the UK is either 18 or 28% depending on your taxable income, with the first £11,000 tax free. The current inheritance tax threshold is £325,000 with a 40% charge placed on anything above this. There are alternative investment structures available which enable investment in more tax efficient ways.