For many people, investing in bricks and mortar by buying second or subsequent homes makes financial sense. Property is a solid, reliable investment that holds its value, right?
Yes, and no. While investing in real estate has its advantages, there are also significant drawbacks to this approach. Here we compare property to other investment options in relation to some key cornerstones of successful investing: liquidity, risk and returns, diversification and tax efficiency.
A key question to ask before investing is how easy will it be to retrieve your capital? This is known as liquidity.
There are various reasons why you may want to ‘cash in’ an investment. It could be that the asset is performing badly, or you have found a more attractive opportunity elsewhere. It might simply be that your circumstances have changed and you need to access your money.
Liquidity is not just about how easy it is to sell up, it is also whether you can do so without taking a loss. Generally, the more illiquid an asset, the higher the risk and potential returns, as you are likely to be rewarded for locking your money away over the longer term.
On one end of the spectrum you have cash and bank deposits, which are easy to access but offer the lowest risk and expected returns. Property sits at the other end. If you are playing the long game, you could find your investment grow substantially over the years. However, it may take time to find a buyer and you could invite a significant loss if you sell at the wrong time.
Investment funds, on the other hand, combine a suite of different assets that may include property (or shares in property companies) alongside equities, bonds, etc. Because there is an established market for the underlying assets, it is much easier to find an instant buyer. Also, unlike property, if you require small amounts of cash you can just sell the amount you need, not the whole investment.
Risk and returns
Generally, low risk means settling for low returns, while taking on more risk brings potentially higher rewards.
For bank deposits, the risk/return factor is low – you have a high certainty of receiving a set amount at the end of the term. However, with today’s interest rates being close to zero, this may struggle to keep pace with inflation.
Property offers less certainty and therefore greater potential for higher long-term returns. However, there is no guarantee that the property will increase – appreciate – in value, especially when you want to sell. You also need to consider the ongoing costs of maintaining and renting out property, as well as the tax implications, to work out what you get back compared to what you have put in.
Other investment options offer the flexibility to change strategy in line with market developments. For example, although the underlying assets in an investment fund are linked to market movements, the fund manager is able to fine tune the portfolio according to what is or is not performing well.
It is important not to be overexposed to any asset, including property. A good portfolio spreads risk across asset types, regions, currencies and market sectors to limit exposure in any one area.
If you already own a house, buying a second property may make you overweight in this one asset class, especially if you don’t own many equity or bond holdings. When property prices drop, both your properties will probably fall in value, while other asset classes may be performing well.
Holding a range of different investments within each asset class helps reduce risk further. You could, for example, own shares from a range of completely different companies and sectors across the world. However, most people can only afford to buy one or two investment properties, giving them little or no diversification.
British expatriates also need to consider exchange currency risk. Rather than tying up your capital in either sterling or euros, some investment structures allow flexibility to hold investments in multiple currencies and convert when it suits you.
Wherever your property is, you are likely to face some sort of council tax, stamp duty and capital gains tax charges. Those with UK property may have felt the burden of recent tax increases on residential properties.
Consider all the assets you already own, including the house you live in, to determine the best approach for you. There may be legitimate opportunities available in your country of residence that offer much better tax advantages and returns than property. Ultimately, you should aim for a balanced portfolio that will suit your unique aims and circumstances, today and tomorrow.
Tax rates, scope and reliefs may change. Any statements concerning taxation are based upon our understanding of current taxation laws and practices which are subject to change. Tax information has been summarised; an individual is advised to seek personalised advice.