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We consider the argument for and against putting money into the real estate sector if you’ve already got a mortgage
Thursday 24 Sep 2020 Author: Hannah Smith

It’s a commonly held view that homeowners don’t need any other type of exposure to the property sector to be well diversified in investment terms.

But does owning a residential property in which you live provide enough exposure to that asset class? Or do you need exposure in another way? Let’s consider the arguments on both sides.

The case against investing in property funds

When you own a home, you usually own it for decades and over that time there’s a chance it will go up in value.

Since 1952, UK house prices have risen by an average 7.7% a year (albeit the annual actual growth is much lower since 2017), according to the Nationwide House Price index. This means your slice of exposure to the property asset class is growing as your ‘investment’ increases in value.

But even if it did fall in value, your house is still serving its purpose as a place for you to live, so you’re not really losing out – after all, you’re probably not trying to sell right now.

If you’re investing in property through an investment fund, you’re more likely to have a broader spread of property types, including both commercial and residential, and potentially a mix of property shares, real estate investment trusts and even exposure to physical property.

These various assets will behave in different ways and you will be exposed to the vagaries of the stock market, and possibly with more volatility than the wider market. As such, it’s no longer just a binary bet that a single real asset (your house) will rise in value over the next 30 years.

LESSONS FROM PROPERTY FUND SUSPENSIONS

Dealing has been suspended in numerous open-ended property funds since March, tying up more than £20 billion of investors’ capital as funds were unable to accurately value their underlying properties in fast-moving markets.

Although they are now starting to reopen, this saga has reminded investors once again that these property funds do struggle in challenging markets, and that physical property is an illiquid asset. This could be a compelling reason for those not wanting to invest in property beyond their own home.

Another key point is that a mortgage can be a cheap form of debt. Anna Sofat, associate director of wealth at financial planning group Progeny, says property buying is the only time she would ever advise her clients to leverage up, namely buying a bigger home.

‘You get value from it and there is (fingers crossed) future equity in there. And if you don’t make money then you have still lived in it and got value from having that bigger property.’

The case For investing in property funds

Let’s now consider the argument for property investing alongside home ownership. If you own your home outright, it might be your greatest asset, accounting for a large percentage of your overall wealth.

Those who have a large outstanding mortgage or high maintenance costs might feel their home is more like a liability. It’s for this reason that Leanne Lindsay, chartered financial planner at Edinburgh Wealth Management, says people should have property investments in addition to their own home.

‘Although some people class their home as an asset, it is actually a liability,’ she says. ‘They may have some equity within their home, however, as they need somewhere to live, it’s not an asset that can be sold easily to repay another debt.

‘If someone’s property was sold, the person would need to rent and potentially have greater outlays. For this reason, although your home is an asset on paper, it costs you money and therefore is a liability,’ she explains.

INHERITANCE PLANS

Sofat at Progeny always asks clients what they plan to do with their property in a wider financial planning context. If they intend to leave it to their children, she would exclude it as an asset, but if it will be sold or the value realised in another way while the owners are alive, then it should be factored in to overall wealth.

If you cannot include your home as an asset and don’t own any property investment funds, then effectively you have no exposure to the property sector and so you’re not fully diversified.

Another issue to consider is the fact that physical property is hard to shift quickly. You might be sitting on an asset but how are you to realise any of that value without selling up?

Unless you go down the path of extortionate equity release schemes, you can’t use your property as a cash machine, like you could if you wanted to just sell a few shares in a property investment trust to raise some quick cash. ‘Physical property is incredibly illiquid, including your home. You can’t sell a brick or two,’ says Sofat.

DIVERSIFICATION STRATEGY

Property as an asset class is not one homogenous mass. By owning a single residential property, you’re not participating fully in the property sector, you have very granular exposure, and you won’t be achieving true diversification.

‘I would class property assets as a rental property, direct investment into commercial property or holding property funds,’ says Lindsay at Edinburgh Wealth Management.

‘Many property funds invest in areas like retail, industrial, retail warehousing, leisure and hospitality, and offices. By holding a direct investment in property such as a rental property or commercial let, you do not have exposure to the other property assets contained within property funds.’

Even if you were a landlord with a handful of rental properties, she would still suggest around a 5% allocation to property in your investment portfolio to ensure diversification, reduce risk and give you the opportunity to get returns uncorrelated to bonds and equities.

Finally, property investments can give you an element of inflation protection that can be very valuable in the long run.

‘The only two asset classes that give you better-than-inflation returns over the longer term are property and equities. Having equity property exposure is a halfway house between the two – you’ve got the liquidity of that equity market and then you’ve got some linkage to the returns from the property market,’ says Sofat.

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