As residential property becomes Isa-able, Samantha Soames asks whether investors should be using their tax-free allowance to buy bricks and mortar.
Anyone who has bought a home before 2007 will know how lucrative an investment residential property can be.
Unlike commercial property which has suffered since the recession, lack of supply and increase in demand has kept house prices fairly stable and – most obviously in the south east of England – ever increasing.
In London the average house price grew seven per cent in the year ending October 2012. The Land Registry, which recorded the rise, said nationally house prices rose by an average of 1.1 per cent.
For supply to meet demand, it is generally accepted that the UK needs to build 750,000 new properties of all types by 2025, a target that many commentators believe is unlikely to be met.
Of course the most obvious way of cashing in on the residential property boom was and is to buy second property (or even more) and rent it out, in the belief that the rental income would be higher than the cost of both the mortgage and upkeep of the property.
But post 2007, not everyone can afford to be, or want to become a buy to let landlord. While it is highly likely that house prices will rise, mortgages have got more expensive and inflation has pushed up the cost of maintenance.
Add to all this paperwork and admin involved in BTL and being a landlord can lose its shine.
My home is my Isa?
Two fund managers claim to have come up with a solution for those wanting exposure to residential property, but without the hassle of rental voids or problem tenants. Hearthstone has launched an open-ended residential property fund that can be included in an individual savings account (Isa) or a self-invested personal pension (Sipp). Castle Trust has also launched two structured products which are Isa-able; the Income HouSA which tracks any rise or fall in the Halifax House Price Index, and the Castle Trust Growth HouSA which offers a gain of between 1.25 times and 1.7 times any increase on the Halifax index or a loss of between 0.75 times and 0.3 times any decline. The TM Hearthstone UK Residential Property fund is, if you like, a buy-to-let landlord and invests in physical residential property assets. The fund buys up professionally managed properties and has a benchmark to exceed the UK House Price Index across England, Scotland and Wales. Residual rental income, left over after costs, is reinvested back into the fund. Both Castle Trust’s funds are pre-packaged investments in that they use derivatives, such as securities, indices and commodities to offer investors a return.
Why haven't these funds been available as Isas before?
Chris Down of Hearthstone points out that funds investing in residential property were available but only offshore and therefore could not be included in an Isa.
Words of warning
Danny Cox of Hargreaves Lansdown says funds such as Hearthstone’s will not suit all Isa investors and that the structured nature of the HouSA was not appropriate for most investors. He says: “One of the ideas behind these types of funds is that investors can use this fund in an Isa to save for their deposits so that they aren't missing out in the rise in house prices while they save. The key point is, if you are investing for the next say five years, do you think residential housing will perform better than the stock market and that is what investors have to ask themselves."
Cox points out that while average prices are rising the residential property market is in the doldrums in comparison with its mid-1990s to mid-noughties ‘glory years’.
He said: “The rise in the average UK house price is skewed due to locations such as part of London and in many cases is flat at best or even falling. On average, I would expect the market to continue to stagnate, or certainly not rise more than a couple of per cent.
“This fund may do better, but with a total expense ratio of 2.7% returns could easily be negative. “In preference, I would opt for an equity income fund with a proven fund manager where the yield is around 4% and the chance of capital appreciation. Artemis Income would be a recommendation.”
So what are the pros?
Return. Residential property returns have been very stable historically and averaged around 14% per annum since 1970.
Minimal investment. You can invest from £1000, unlike the hundreds of thousands you would need to get direct exposure to the rental market.
Inflation hedging. House prices have has consistently outperformed RPI inflation.
and cons?
Past performance. The funds have only just been launched so no past performance data is available.
Costs. Property funds generally cost more to run than equity funds.
Property doldrums?There may be a downturn in the property market.
An illiquid investment. Some advisers dismiss the idea that an open-ended fund can make illiquid assets liquid, using the example of commercial property mutual funds in 2008, when some funds put limits on withdrawals due to the high number of withdrawals.