If I stated that property investment requires a substantial amount of capital to get established, you would certainly not be surprised.  Currently banks and building societies require a significant proportion of an investment property purchase cost as equity.  I hazard a guess that this situation is generally, highly unlikely to change in the near future.  Investors now fully understand that a property/portfolio that is based upon a high level of debt is simply too risky.  I personally don’t believe this new behaviour to be a bad thing.

So, an example property costs £200,000, therefore the mortgage provider is likely to require you to provide around £40,000-£50,000 as deposit.  In addition to this-SDLT, management costs and transaction costs must be included.  This amount might be too high for many prospective investors to enter the market.  Investment in this way is known as ‘direct property investment’.

Many people prefer to invest in a gradual manner rather than investing a large amount in one go.  It’s also very important to many to seek a ‘spread’ by diversifying their investments within the portfolio.   Diversification might be in several different ways: across property types, across fund types and across investment types.  This leaves them less exposed to the various risks involved with each investment (all investments involve an element of risk to some degree).

Property investments enjoy a particular pattern of behaviour owing to their lack of liquidity, relative attractiveness of tangible assets and the facility to easily increase their capital value.  For an insight into the particular characteristics of property as an investment class, look at my other post ‘why property still makes an excellent investment’.  If an investor wishes to take advantage of this behaviour but does not wish to invest directly, there are several routes to consider.

1. UK authorised property unit trusts. This is a collective investment scheme that invests up to 100% of capital in property.   Other related investments such as limited partnerships can also be included.  Individual units are purchased whose value is directly related to the value of the assets held by the trust. Unit trusts are ‘open-ended’, this means that the number of units increases or decreases depending on whether additional money is invested or withdrawn by other investors.
2. Unit linked life and pension funds.  A number of life insurance and pension companies have funds that invest directly in property. Often, they can be one of a range of investment options available as part of an occupational or personal pension scheme. These funds primarily invest in the UK, as they are conservative in nature, but an increasing number offer overseas property investment options as well.
3. Life bonds.  In contrast to most of the other indirect property investment methods, life bonds are life insurance policies usually purchased as a single premium product. They are invested in a ‘with-profits’ or unit-linked life fund. They can invest in both UK and overseas property.  A particular advantage of life bonds is that the holder can withdraw up to 5% of the bond each year without a tax charge.
4. UK REITs.   A ‘REIT’ is a Real Estate Investment Trust.  It is a classification of property investment company that meet certain criteria; such as having to distribute 90% of the trusts taxable income via dividends and 75% of assets must be real estate. The REIT regulations are intended to ensure the company is primarily engaged in property investment, rather than in development or other non-property related activities.  Investment into this class is through REIT company shares.  Most UK REITs focus on the UK, though a few have European investments. This sort of specialisation is a global characteristic of REITs, and reflects the diversity of legislation in some countries.
5. UK listed property companies (non REITs).  This is an investment in the purchase of shares in publicly listed property companies that have not elected to convert to REIT status. This might be because the company does meet the particular REIT criteria, such as a lower proportion of their income is from real estate.  Most listed property companies stick to investing in the UK.
6. Offshore UK property investment companies.  This is an investment in the shares of property companies that are listed on the London Stock Exchange, but are based in the Channel Islands to ‘escape’ the taxes suffered by UK property companies other than REITs. These companies tend to focus on a single country for their investments, although a number have opted for a European investment focus.  As these companies are not UK resident, they are not liable for capital gains tax on gains arising from the sale of UK property held as an investment. Profits on UK rent are taxed at 22%, but may be mitigated, and it is often possible to achieve a true marginal rate of tax as little as 5%.
7. Investment trust companies. These are investment trust companies, approved by HMRC, and are listed on the London Stock Exchange, and primarily invest in UK and global property shares. Many are resident offshore for tax purposes.  Investment trust companies are exempt from capital gains tax, and provide a low-cost way of gaining exposure to UK or global property through shares. As a result, they do not suffer from the cash management issues and cost / time constraints that unit trusts incur through investing in property. They can, therefore, be more flexible in their investment portfolios and strategies, and may be able to enter and exit markets much more quickly than investors in direct property in unit trusts.
8. UK limited partnerships. A property investment limited partnership is a partnership business that invests in and derives returns from property. Each partner subscribes capital to the partnership and receives a share of the returns. Investment levels tend to start from around £25,000 for individual investors but many partnerships will involve investments of many millions of pounds. Whilst limited partnerships can invest directly in property, the majority invest in closed-ended funds operated by professional managers.
9. Property derivatives. Property derivatives are sophisticated investment products that do not invest in property or property securities, but whose performance is based on that of the property markets, as measured by indices. They can track the performance of any established property index in any area of the globe. Derivatives can take a number of different forms including:Spread bets, contracts for difference (CFDs) and exchange traded futures (ETFs) ‘Over the Counter’ (OTC) instruments such as forwards and swaps.Most derivatives are only intended for institutional investors and investment professionals, although certain types of derivatives, such as CFDs may be available for retail investors, particularly those based on residential property indices. Derivatives offer access to property investment returns without investing in property or property securities, and as a result with minimal transaction costs. For property professionals they offer opportunities to hedge or de-risk their direct property investments.

Investment information compiled with reference to the website of The London Stock Exchange.

The main advantages of indirect property investment are that the investor is not ‘committed’ to a single, expensive asset.  There are no management or transaction costs associated with indirect property investment either.

The investor is clearly free to make the decision whether to invest directly or indirectly; but as with all investment, risk is always present to some degree.