Should you own property or REITs?
For the last few years, it seems that whenever anyone has mentioned the subject of investment the majority of people will instantly think of buy to let or buying second homes and flipping them. It’s hardly surprising when the majority of daytime TV is filled with images of Sarah Beeny and Phil Spencer finding fantastic bargains that are then either flipped or let out for a juicy profit. This has been a fantastic plan for many people in the UK and has certainly made a lot of people a lot of money. But is this still really the case?
New tax rules
In 2016 the UK government brought in a series of new tax rules that have had a profound impact on the buy to let market. The two main changes that have been introduced are changes to the tax that can be claimed from renting out a second house, and changes to the stamp duty that has to be paid when purchasing an additional property.
The first change will remove the landlords’ ability to deduct the cost of their mortgage interest from their rental income when they calculate the profit on which to pay tax. What this means is that the government wants to tax landlords on their turnover rather than their profit, meaning that tax could even be payable on non-existent income. In some instances, tax rates will exceed 100%, so landlords will have to pay all of their profit in tax, and then pay even more on top. This tax increase will be phased in from 2017 and will be fully implemented by 2020.
It’s been calculated that those landlords who have mortgage interest which is 75% or more of rental income excluding other expenses, will see all profits wiped out by 2020. For additional-rate taxpayers, the threshold at which their investment returns are wiped out will be when mortgage costs reach 68% of their rental income.
New stamp duty rate
The second change that’s being introduced affects the amount of tax that is paid when purchasing a second property. Landlords are now being hit with an extra 3% charge on each stamp duty rate band, which varies by property value. This means that landlords will have to pay 3% for the first £125,000 and 5% instead of the previous 2% on the amount between £125,001 and £250,000.
Now I can see on one hand where the government is coming from. There’s a housing crisis in the UK at the moment whereby an entire generation of people have been forced out of house ownership by a combination of poor credit, low wages and lack of available houses. This situation hasn’t been helped by wealthy landlords buying housing left, right and centre and turning them into buy to lets.
However, on the other hand, why shouldn’t anyone who’s worked hard to save enough to buy a second property go ahead and try to make a few extra quid? Why shouldn’t you be able to make your lot in life just a little bit better and more profitable? It seems to me that every opportunity that gets opened for the average man or woman on the street gets closed again by the government.
Rental can be a pain in the…
I’ve owned a property in the past which I’ve let out and in my opinion, it really isn’t the easiest way in the world to make money. For starters, you need a letting agent to find potential tenants and then look after the ongoing rental. I was charged the princely sum of 12% of the rental income for this, which isn’t even excessive when comparing all the agents in the local area. In addition, I then had to declare my rental income to the good old HMRC for tax. Along with tenants that decided to skip payments, damage done to the property by clumsy tenants and tenants that constantly complained about everything from the colour of the paint to the pile of the carpets, I decided enough was enough and sold up.
This left me with a question. If it’s no longer worth my time owning bricks and mortar other than my own home, how can I invest in property as a diversifier to my investment portfolio?
A property alternative
The answer came with a bit of googling on the subject and reading about what other ex buy-to-letters are doing. I’ve mentioned before about my preference for Investment Trusts and how they make up the majority of my portfolio, but there’s another form of trust that I now own, which is known as a REIT, or Real Estate Investment Trust.
A REIT is a company which owns its own portfolio of properties and sells shares of itself on the stock market. These shares can be purchased in the same way that shares of any company can be purchased through your trading platform, but they offer the added diversification of bricks and mortar in a variety of formats. For example, you can by residential property REITs, commercial property REITs or industrial property REITs both in the UK and anywhere else in the world that the trust has invested in.
Another benefit of holding a REIT instead of physical bricks and mortar is that it’s much, much easier to buy and sell. There are no solicitors and no mortgage providers to deal with, only your trading platform, and you can even buy and sell on the same day if you really want to.
They also pay a remarkably good dividend because a requirement of the company holding REIT status is that the trust must pay its shareholders 75% of their profits in dividends. If nothing else holding property in this way within your portfolio provides some diversification from the ups and downs of the rest of the stocks that you hold, although that’s not to say that the REIT won’t rise and fall in value too.
If you’ve had enough of buy to let and want simple exposure to property with fantastic liquidity, I strongly suggest you fire up Google and do a bit of further research on REITs as an investment.