Investing in rented property, is it the right move?

Investing in rental property is often an excellent move for investors. With that said, it isn’t the right move for everyone. With that in mind, Pure Investor share their points on what to consider before you decide whether or not investing in rented property is for you.

What is your main investment goal?

In other words, are you mainly interested in capital appreciation or are you mainly interested in income? It’s quite understandable if you’d like to have both but you need to be clear on which takes priority.

If your main priority is to grow your capital, then investing in rented property may not be the right option for you. Property does, generally, appreciate over time. It is, however, unlikely to match the performance of growth stocks. With that said, it’s also less risky. Growth stocks tend to have a high failure rate although those that succeed can make up for it.

If your priority is income, by contrast, then investing in rented property can be an excellent move. With proper tenant selection, rented property should provide a consistent monthly income. This can do a lot to keep your cash flow smooth in between dividend payments.

How much investment capital do you have?

Buying property generally requires you to commit significant capital. This may require you to use leverage (i.e., get a mortgage). Even if it doesn’t, it’s going to tie up cash so you need to be sure you can live without it.

You also need to keep in mind that buying investment property does put your capital at a certain level of risk. The price of property as a whole tends to go up over time. It is, however, possible that any property you buy could fail to appreciate or even lose value.

Realistically, the major issue with property is that it is generally very much a buy-and-hold investment class. As a rule of thumb, you should only buy property (including residential property) if you anticipate being able to hold it, comfortably, for at least five years. Three is a bare minimum.

The longer you can hold property, the more time you have to absorb the transactional costs of buying it. Keep in mind that these are usually much higher than the transaction costs of buying other investments. You’ll also give inflation more time to do its work.

A note on mortgages

As an investment buyer, you will usually have the option to use either an interest-only mortgage or a repayment mortgage. It’s worth taking the time to think carefully about this decision.

You can get the benefit of capital appreciation with either but you will only build up equity in the property with a repayment mortgage. Furthermore, interest-only mortgages tend to be more affordable in the early years. Over time, however, repayment mortgages become more economical. This is because paying off the principal reduces the amount of interest payable.

You also usually have the option to have either a fixed-rate or a tracker mortgage. Again, this is a decision that’s worth taking the time to consider thoroughly.

On the one hand, fixed-rate mortgages tend to be more expensive than variable-rate ones. As a rule of thumb, this differential increases with the length of the fix. On the other hand, fixed-rate mortgages give borrowers predictability. This is especially important for landlords who need to be able to set rents.

What is your current spread of assets?

If you invest all your cash in property, then you are effectively putting all your eggs in one basket. This can work out well but if it doesn’t you could find yourself having to swallow down significant losses. It is therefore usually much better to move into investment property once you’ve already built a portfolio of other assets such as stocks and bonds.

At that point moving into property not only diversifies your assets, but it can also help you to manage your taxes. For example, if you are already maximising (or exceeding) your tax-free allowance for dividend income, it can be very sensible to move to another income stream. Property can also be a hedge against inflation.

Keep in mind that there are numerous options for investing in the broader property market without actually buying investment property. For example, you could buy stocks in and/or bonds from companies directly linked to the property market such as home-builders. More broadly, you could invest in companies with home-related products and services.

How much time do you have to manage your investment?

These days, there are probably very few buy-to-let property investors who can manage their investment entirely by themselves. The residential rental market has become very highly regulated over recent years. What’s more, the onus is generally on landlords to show that they have complied with the law rather than on tenants to prove that they haven’t.

This means that most landlords, particularly small-scale ones are going to need to work through intermediaries such as lettings agents. Even so, property can be relatively labour intensive as compared to other investments.

For example, it can take a lot more work to find suitable investment properties. It can also be more challenging to monitor their investment performance as there can be fewer direct comparables. It will almost certainly make your tax returns more complicated, so you’ll probably need, or at least want, an accountant.

Would it be better to invest in commercial property?

If you’ve decided that investing in property is for you, then your last decision is whether you want to invest in residential or commercial property. Keep in mind that commercial property includes purpose-built student accommodation, purpose-built retirement accommodation and short-term rentals as well as properties such as offices, retail outlets and warehouses.

Commercial landlords do still have legal responsibilities towards their tenants. The sector is, however, much more lightly regulated and can be very profitable. Holiday lets are probably the current stars of the commercial-property area. They do typically require a lot of management, but they can generate outstanding returns.

By contrast, purpose-built student accommodation and purpose-built retirement accommodation both tend to generate stable, reliable income with no effort. There is also still demand for other forms of commercial property as many businesses require at least some workers to be on-site at least some of the time.