1. Advanced Financial Advice Coursework Submission
Possibilities in Property
A discussionof the various approaches to investing in property
By Matt Gray
Property, the ever-popular asset class, has been the making of many wealthy investors, but
conversely it has also been the undoing of many, particularly in recent years.
What is it about property investing in general that has brought it such popularity? In part this
must be due to the familiarity that most people feel with it, almost every potential investor will
live in some form of property, whether by renting or purchasing, and in doing so they will
gain a basic understanding of many aspects of the residential property market. Those who
own their residence will already have invested and for many their property will be the most
valuable thing they own.
This necessary everyday involvement with property means that banks and lenders are
generally more comfortable lending to the public via mortgages on property than providing
loans backed by any other asset class. Likewise people are much more comfortable taking
large loans to fund property investments than with other asset types – just imagine trying to
explain to friends and family that you were planning to borrow a few hundred thousand
pounds to invest in equities!
This is where the effects of gearing come into play. By borrowing money to increase an
investment one can significantly increase any gains or indeed any losses. An extreme, but
not unrealistic example is shown in calculation 1.

2. Calculation 1
Suppose someone with ten thousand pounds was to take a ninety percent loan to value
mortgage and purchase a house for one hundred thousand pounds. If the value of the house
plus any rent collected was to increase by ten percent over the course of the investment
(after costs and interest), then the investor’s original ten thousand pounds would have
brought him a return of one hundred percent. Similarly however, should the value of the
house plus rent collected fall by ten percent then the investor would have lost one hundred
percent of his initial investment.
Historically UK house prices have tended to rise faster than mortgage interest rates in the
long term, therefore people tend to encounter the benefits of gearing more often and so see
this opportunity as an added incentive to choose property as an investment medium.
Gearing like this also carries significant exposure to interest rate risk. If interest rates
increase the effect is proportionate to the size of the loan, highly geared properties can fall
into negative monthly cash flow if mortgage payments outstrip the rent collected.
Another slightly simpler reason why people may prefer to invest in property is a
psychological one based on the fact that property is a much more tangible asset than many
other forms of investment– they can physically see, judge and even use what they have
bought, it is large in size and possibly also attractive and desirable. People’s psychology
around investment varies hugely but this is one factor that seems to widely encourage
people and increase their faith in property. It also allows skill to play a part; because people
generally have greater understanding and access to a property they plan to buy, they have
the potential to judge good and bad properties with greater skill than say equities for
example. Let’s say they can identify an undervalued property in an up and coming area with
increasing rental demand. They would then have the potential to significantly beat the
returns of the average UK residential property.

3. Skill can play a part in other ways too, for example a skilled tradesman or project manager
can carry out work to increase the value of properties in a profitable way. However at some
point one must make a distinction between an investment and a business and for the
purposes of this article I will consider any major renovation or redevelopment activities to be
the latter and look instead at the options most viable to the ordinary investor.
Of course another key part of the popularity of property, as with any investment, is based on
its track record. UK property has historically performed well- similarly to UK equities as
shown in Chart 1 below, however in recent years investors have been reminded of what was
for some a forgotten fact – that property prices can fall.
Chart 1
Source: Morningstar Adviser Workstation, July 2014
Another factor in property’s favour is that it has historically demonstrated a relatively low
correlation to most other asset types as shown in Table 1 below. This gives it the added

4. benefit of bringing significant diversification to a portfolio, thereby enhancing portfolio
performance and reducing an investor’s exposure to non-systemic risk – the collapse of any
one particular industry, asset type or sector.
Table 1
(www.hearthstone.co.uk)
Residential Property
This is the largest sector of the property market as shown below in chart 2. Investors in
residential property fall into a range of different categories.

5. Chart 2 - Value of UK Residential Sector
(www.bpf.org.uk)
Home Ownership
Of course much of this market will consist of people who may not even consider themselves
to be investors- those who simply own their home. There is a prevailing culture in the UK to
do so. The idea of one day owning one’s home unencumbered is seen as a staple of
financial security. The reality is however that making the decision to buy rather than rent a
home is indeed an investment and carries with it potential risks as well as rewards.
There are of course those who are highly aware of the investment nature of home ownership
and who even do so strategically for this purpose. This method of property investing has a
number of advantages:

6. - Mortgages are significantly cheaper for owner-occupiers and a wider range are
available. They also tend to accept smaller deposits than would be required for say a
buy to let mortgage.
- Although no rent is earned, by living in the house one can offset the rent one would
have had to pay elsewhere. In this way there is guaranteed occupancy of the
property with none of the management fees or risk of getting a bad tenant.
- Repairs and improvements can be carried out on the house over a long period of
time and paid out of earnings if savings aren’t sufficient. The hope is then that the
resale value will be increased by more than the cost of the improvements, adding to
the returns made on the investment.
Some of the disadvantages to consider would include:
- The purchase cannot be considered purely from an investment point of view; it will be
necessary to choose a property that meets the buyer’s needs and is desirable
enough for them to live in – this may rule out some of the most profitable investment
properties.
- The need to live in the property may also mean that the chosen purchase is of higher
value than would otherwise be invested – increasing the risk and stretching finances.
- Along the same lines as above, a buyer might also make compromises in the
standard of the property that they might not have done were it purely for living in. As
well as this any ongoing renovations and improvements can be extremely disruptive
especially if carried out over a long period of time.

7. - When owning a residence one sacrifices the flexibility of renting- there are greater
costs associated with moving. Similarly as an investment it is illiquid, taking time and
money to sell.
- Maintenance and other costs will be the responsibility of an owner-occupier where
they would not have been that of a tenant.
- Investing such a large amount in a single asset class leaves one highly exposed to
risk of property sector collapse.
Tax Treatment
There are a few tax advantages to investing in property as a home owner:
- There is currently no Capital Gains Tax payable on a primary residence. Consider
the example in calculation 2 below:
Calculation 2
lf an investor who is already a higher rate tax payer, were to sell a property that they did not
live in for £150,000 having bought it five years earlier for £90,000 and spent £10,000 on the
costs of buying and selling the property they would have made a capital gain of £50,000.
Everyone has an annual tax free capital gain allowance of £11,000, leaving a taxable capital
gain of £39,000 to be taxed at 28%. This would result in a tax liability of £10,980 – a
considerable sum and a sum which would not have been due had the property been the
investor’s primary residence.
- As previously discussed, by living in a house an investor could consider that they are
offsetting the rent they would have been paying elsewhere. So this rent saving is
effectively part of the yield from the investment, however there is no requirement to

8. declare it and no tax payable on the saving. Were the investor to be renting the
house out instead, and charging the same amount of rent as would have been offset,
this would then be taxable income taxed at the applicable rate band(s) based on the
investor’s other earnings.
- The converse of the above is that any expenses for repair and maintenance on an
owner-occupied residence are not deductable against any other taxable income.
- Stamp Duty would still be charged at the applicable rate. Rates are shown in Table 2
below.
Table 2
Rate of SDLT (percentage of the total purchase price)
Up to £150,000 - annual rent is less than £1,000 Zero
Up to £150,000 - annual rent is £1,000 or more 1%
Over £150,000 to £250,000 1%
Over £250,000 to £500,000 3%
Over £500,000 4%
(www.gov.uk)
- The government’s rent a room scheme could be used to provide tax-free income by
renting spare rooms in the owner’s primary residence.
“The Rent a Room Scheme lets you earn up to a threshold of £4,250 per year tax-free from
letting out furnished accommodation in your home. This is halved if you share the income
with your partner or someone else.”
(www.gov.uk)

9. Buy to Let
This type of investor seeks to rent out the property to provide a regular income. Beyond this
there are a number of different strategies. Some may seek to simply cover their interest-only
mortgage payments and maintenance with the rental income and expect to profit solely from
the capital growth. Others put the focus much more on the rental income by purchasing low
price houses and renting them out to low earners or those in receipt of housing benefit.
These low cost houses typically offer the best yield as the rental value does not decrease as
steeply as the price of the houses toward the bottom of the price range.
Another strategy to maximise rental income is to offer a house of multiple occupancy or
HMO where each tenant agrees a separate lease for renting a specific room and sharing
other facilities. The total of the rent from all tenants in an HMO will usually be considerably
higher than if the house were rented out entirely in a single lease although this method does
carry the extra hassle of arranging multiple leases, also building requirements, particularly
around safety features, are more stringent so bringing older houses up to standard can be
costly. This strategy is normally targeted at students or young professional tenants but
alternatively, specialist accommodation for the elderly can also attract higher rent. Each type
of tenant will bring about different costs and challenges associated with the investment.
Lastly, another option for maximising rental income is to purchase a property with more
desirable location and/or features and market this for short-term holiday lets. Typically these
lets are a week or two at a time but can be as little as a weekend or a few days. Prices are
several times higher than typical residential lets however the level under-occupancy is likely
to be much higher particularly during off-peak times. This method of buy to let is once again
leaning more toward being a business in itself rather than simply an investment. Demands
on the owner in terms of time and/or costs will vary depending on the specific set up but are
likely to be significantly higher than with longer term residential lets. Marketing may be

10. required, which means time and money spent researching, creating and publicising your
ads. Cleaning, maintenance and redecorating will be required much more frequently. Also, to
justify higher prices, guests will expect a higher standard of internal decoration and
furnishing. One of the key benefits with this type of investment is of course that if they can
afford the time the investor and their friends/family can make use of the property when it’s
unoccupied – not many investments offer free holiday accommodation as part of the return!
Management companies are an option available to the buy to let investor – they take on the
work involved in finding and managing tenants and property maintenance in return for fees
and a percentage of the rent. Using a good management company to find tenants should
reduce the risk of ending up with a bad one. They carry out interviews, check references etc.
to vet tenants thoroughly before signing them up. With ongoing management they can
simplify issues by dealing with tenant queries, repairs, etc. but the monthly charges will eat
into cash flow which may already be tight. Also when arranging any maintenance work on
the investor’s behalf they are unlikely to be as discerning on price as the investor
themselves.
Tax Treatment
There are not many tax advantages to investing in property as a buy to let. In general the tax
treatment is as follows:
- Stamp Duty will apply to purchases at the normal rates.
- Capital Gains tax will be chargeable on gains from the sale of any property that is
not the owner’s primary residence. (Where the gains made in that year exceed the
individual’s £11,000 annual allowance)
- Rental properties owned will form part of a person’s estate for inheritance tax
purposes.

11. - Income tax will be payable on profits from rental income each year. There are
allowable expenses that can be offset against rental income. These are described
as follows:
“Allowable expenses are things you need to spend money on in the day-to-day running of
the property, like:
 letting agents’ fees
 legal fees for lets of a year or less, or for renewing a lease for less than 50 years
 accountants’ fees
 buildings and contents insurance
 interest on property loans
 maintenance and repairs to the property (but not improvements)
 utility bills, like gas, water and electricity
 rent, ground rent, service charges
 Council Tax
 services you pay for, like cleaning or gardening
 other direct costs of letting the property, like phone calls, stationery and advertising
Allowable expenses don’t include ‘capital expenditure’ - like buying a property or renovating
it beyond repairs to wear and tear.”
(www.gov.uk)
Commercial Property
“During times of economic uncertainty investors often look for an investment diversifier, that
helps to spread risk away from traditional asset classes and can provide an attractive and
stable level of income above inflation. UK commercial property, with its attractive yield profile
and low correlation to traditional asset classes, such as equities and bonds, continues to
provide investors with solid levels of rental income and steady returns.”
(www.henderson.com)

12. In general commercial property offers a few key advantages over residential property. These
stem from the nature of the tenants - generally established businesses needing secure, long
term premises in which to invest and build a customer base. The results are longer leases,
higher yields and less work to do as a landlord because tenants generally look after the
internal furnishing, decorating, maintenance and repair of the building. Only the structure
and exterior of the building is usually the responsibility of the landlord.
Capital growth in commercial property however has been slower but prices are considered to
be steadier than residential property. Chart 3 below shows how both sectors have performed
over the past 40 years to 2012:
Chart 3
(www.hearthstone.com)
Again the issue of liquidity will arise if purchasing a commercial property, both buying and
selling will take time and cost money, this means that commercial property is also mostly
suitable for long-term investors as part of a large portfolio.

13. Tax Treatment
Essentially the tax treatment of commercial property is very similar to that of residential
property. Again the rules for stamp duty, income tax, capital gains tax and inheritance tax will
all be applied. There are a few options available with commercial property that would enable
an investor to mitigate some of these:
- Business Property Relief
If the commercial property purchased is used by the investor’s own business (one that he
has a partnership or controlling shares in) it may qualify for business property relief which
can reduce inheritance tax by 50%. The business would need to be actively trading and
making use of the property and the property must have been held for at least two years
before the death of the owner.
- Self Invested Personal Pensions
Commercial property can be held in a self-invested personal pension (SIPP). Investors can
gain income tax relief by investing their income in a SIPP or those with other existing
pensions can transfer pension benefits into a SIPP. By buying property in this way one gains
all the tax advantages of a pension pot i.e. there will be no income tax on rental income
(which must be re-invested in the SIPP), no capital gains tax if the property increases in
value and no inheritance tax if you die – the property should be fully exempt within a SIPP,
an enhancement on the 50% BPR mentioned above. Lastly, if you occupy & rent the
property with your own business the rent you pay to your SIPP is an allowable expense and
helps offset income/corporation tax.
- Stamp Duty Land Tax
The rates of SDLT also differ slightly for commercial property as shown in table 3.

14. Table 3
Non-residential and mixed-use properties
Purchase price/lease premium or transfer
value
Rate of SDLT (percentage of
the total purchase price)
Up to £150,000 - annual rent is less than
£1,000
0%
Up to £150,000 - annual rent is £1,000 or
more
1%
Over £150,000 to £250,000 1%
Over £250,000 to £500,000 3%
Over £500,000 4%
Residential leases - If your residential lease is for more than £125,000, you’ll pay 1% SDLT
on the amount above the £125,000 threshold.
(www.gov.uk)
Indirect Property Investments
A popular and potentially less time consuming way to gain exposure to commercial and/or
residential property markets is by investing in pooled investment funds specifically for
property. These take several forms:
“Indirect Property Investments
• real estate investment trusts (REITs)
• shares in listed property companies
• property investment trusts
• insurance company property funds
• property unit trusts
• offshore property companies”
(www.moneyadviceservice.org.uk)

15. Generally speaking these investments are funds listed on the stock market that invest in
properties. Investors will own shares or units which will reflect the market value of the
underlying properties to some extent, shareholders or unit holders will also receive income
payments called property income distribution (PID) payments and/or dividends based on the
income performance of the underlying portfolio of properties. The funds will usually be run by
managers who apply charges to your investment as payment for their services. This will be
in the form of an annual percentage of the value of your shares, typically 1-2% in the case of
an actively managed fund. There may also be an initial charge on new money invested.
The most common form of these is a real estate investment trust or REIT.
“Reits were established in the UK in 2007 and offer investors a way to own property assets
without buying them directly. Many of the UK’s largest landlords have since converted to Reit
status. The main reason for doing so is that they pay less tax to the government. All the
rental profits and capital gains on rental properties are exempt from corporation tax.
However, there are strings attached: 90% of the rental profits must be paid out in dividends
to shareholders each year, and any profits from property development are subject to normal
rates of corporation tax.”
(www.moneyweek.com)
The benefits of indirect property investments include:
- They give investors exposure to property markets at a much lower minimum
investment, this should allow investors more flexibility in asset allocation as to how
much of their portfolio they wish to invest in property, particularly those with smaller
portfolios who may have had little money remaining to allocate had they purchased
a property in its entirety.

16. - They allow instant diversification as the investment is spread across a portfolio of
properties held by the fund.
- They generally have better liquidity as prices are usually quoted daily and are much
faster and cheaper to buy and sell than a physical property.
- If an actively managed fund is chosen, portfolios are professionally selected and
managed by property investment experts and so can outperform the market
average.
- Many of these investment funds such as REITs can be held in pensions and ISAs to
significantly reduce tax.
- REITs in particular pay less corporation tax than other companies so can return
more profit to investors.
There are however potential drawbacks as follow:
- Getting low-rate finance or a mortgage to increase an investment through gearing is
unlikely and certainly not widely available compared to mortgages for physical
property. Although as discussed gearing is not always a good thing.
- The Financial Conduct Authority (FCA) does not directly supervise REITS and
many other property funds. This means that an investor cannot take a complaint to
the FCA or claim compensation from the Financial Services Compensation Scheme
(FSCS) if something goes wrong.

17. - The investor will not have access to or be able to use any of the properties for their
own purposes at any stage.
- Fund charges will reduce investment performance.
Tax Treatment
REITs and their newer alternative property authorised investment funds (PAIFs) benefit from
several tax advantages.
“A REIT has two separate elements for tax purposes: a ring-fenced property letting business
which is exempt from corporation tax; and non-ring-fenced activities like property
management services which is not. If the REIT you invest in does well, you will receive a
distribution of the profits.
Payments from the tax-exempt element are treated as UK property income for the investor
and are paid net of basic rate tax - non-tax payers can re-claim this and if the REIT is held in
an ISA investors receive payments gross.
Payments from the non-exempt element are treated the same as any UK dividend and paid
with a tax credit.”
(www.moneyadviceservice.org.uk)
Conclusion
There are a range of ways to invest in property, each with their own set of pros, cons, risks
and rewards. Compared to other asset classes such as equities and bonds few, if any, carry
the level of emotional attachment and ability to impact so greatly on the daily lives of the
investors that can be brought about by investing in property.

18. These factors create a unique and perhaps more challenging position for property investors.
The result is that careful consideration and planning are required to ensure that the
investment is suitable, not only for the investor’s budget and attitude to risk but also a range
of other factors such as, time and money available, local knowledge and the desirability and
suitability of the property for its intended purpose.
In comparing property with other asset classes there is no clear overall winner, rather a
diverse range of options which allow investors to find the balance most suited to their own
particular circumstances and investment psychology.
Ultimately however, property has always been a highly popular asset class and has justified
this with historically strong performance and low correlations to other asset classes. This,
combined with the variety of property investment options available, make it a desirable, if not
essential part of the intelligent investor’s portfolio.

19. Part B
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