What Is an Investment Property? Helpful Guide

So, what is an investment property?

An investment property is real estate that has been purchased for the purpose of earning income. You can earn income through both rent and capital gains. Examples of investment property include residential buy to let, student accommodation, houses of multiple occupancies, and more.

For many, 2020 was a horrific year. Many lives were lost due to the covid-19 pandemic, and the economy suffered greatly after three national lockdowns.

Despite this, though, real estate investment flourished.

The average UK property surpassed the £250,000 mark for the first time ever and increased at its highest rate since 2004.

As of December 2020, property prices were 8.05% higher than a year prior, according to the UK House Price Index.

These growth levels have continued in 2021. January 2021 prices were around 7.49% higher than January 2020.

In fact, UK real estate is set to increase in value by another 4% in 2021, with predictions of a 21.1% growth by 2025.

That means if you purchased real estate right now, you would already see over a 20% profit by 2025.

This figure is just the average for the UK, too, with certain areas far surpassing these predictions.

The current highest prediction is for the North West, with prices set to rocket by 28.8% by 2025. This is closely followed by Yorkshire and the Humber, with a 28.2% growth. The lowest growth rates are seen in London, with a 12.6% rise in value by 2025.

It’s not just house prices that are increasing in value, either.

According to the Homelet rental index, the average UK rent is now £984 – a 3% rise year-on-year.

Savills predicts that rent values will increase by an additional 17% by 2025, putting even more money into investor pockets.

As you can see, with such high levels of growth, investing in real estate can be an incredibly fruitful venture.

Despite this, though, there are important things you need to consider before investing in property. Not all property investment strategies are made equal, and there are certain factors to evaluate.

Rental yield is one of the most important aspects of property investment. It is usually the first thing investors evaluate before investing in an area.

Rental yield is the return on investment you get through rental income. It’s calculated by dividing your yearly rental income by the original purchase price of the property and then multiplying it by 100.

For instance, taking the average UK rental income (£11,808) and dividing it by the latest UK House Price Index figures (£249,309), the average UK rental yield is 4.74%.

That means you will see a 4.74% return on your investment every year through rental income.

To get the best investments, you will need to find areas with the highest rental yields. That means a location that has high rental income and low property prices.

What Is a Good Rental Yield for an Investment Property? 

So, what is a good rental yield for an investment property?

Typically, a rental yield between 5 or 6% is considered good.

Luckily, there are plenty of top UK property hotspots that deliver far higher rental yields than the UK average.

Let’s look at five of the most popular UK investment locations: Liverpool, Manchester, Birmingham, Leeds, and London.

As you can see, despite London having a considerably higher rental income, it has the lowest rental yield due to the overwhelmingly high house prices. This means you will wait even longer before you can start profiting off your investment.

This is why London is now considered one of the worst investments for real estate. For the price of one London property, you could buy on average five in Liverpool – that would make your yearly income just under £50,000.

Pairing this with the fact Liverpool, Manchester, and Leeds have the highest future growth predictions of 28.8% and 28.2%, and it’s easy to see which locations are worth considering.

If you want to learn more about rental yield, check out our guide to “what is a good rental yield?”

So, what is positive gearing an investment property?

Positive gearing, or cash flow property, is when you receive more in rental income than you spend on the property. Possible expenditure includes loan repayments, property management fees, interest, and general maintenance.

This essentially means you are earning more than you are losing on a property. Having an increased source of income is great news as it allows you to pay more on your mortgage or even save up and buy another property.

Mortgage lenders will love positively geared property, as they will feel more confident lending cash if you can prove you can comfortably cover costs.

One downside of positive gearing, though, is the increased income tax you will pay.

If you want to branch out into the commercial property world, cap rate is a solid metric to consider.

Cap rate is the percentage of return on your investment while factoring in monthly costs and expenses. This figure is calculated without mortgages in mind, which means cap rate gives you returns expected from just a cash purchase. It is calculated by dividing a property’s net operating income by the current market value and multiplying by 100 to get a percentage.

Mainly used in USA real estate but becoming increasingly popular in the UK, cap rate gives you a rough indicator of the potential of return on a commercial real estate investment. It allows you to compare different property assets without considering the potential unknown of mortgages.

So, what costs do you need to consider? To get as accurate a figure as possible, try and be thorough when thinking about your monthly expenses. This includes rental income, property management fees, maintenance and repairs, and others.

Let’s say you have a total net income on a property of around £12,000, and the property price is £249,309. That means you have a cap rate of 4.8%.

What Is a Good Cap Rate for an Investment Property? 

So, what is a good cap rate for an investment property?

Typically, anywhere between 4% to 10% is a reasonable cap rate for real estate.

It’s important to keep in mind that cap rate isn’t the make or break of an investment – it’s a useful rough indicator to see how total expenditure could affect your income. Many investors will willingly invest in a property with a lower cap rate if the property is found in an area with a high commercial rental demand. Factors like rental yield, market growth, and demand are still essential features worth considering.

Now that you know what makes a good investment, it’s time to evaluate the types of properties you could invest in.

1. Residential buy-to-let 

The most popular type of investment, residential buy-to-let, is likely the safest investment you can make in real estate.

Residential buy-to-let is the idea of purchasing a property to rent to a tenant, ranging from young professionals to retirees.

If you’re asking, “what type of property is best for an investment?” this should be at the top of your list.

Our residential properties start at just £74,950 with returns of up to 8%.

Pros

1. Easiest investment strategy to start with for beginners.
2. Earn consistent income each month through rent.
3. Massive predicted growth for the future, so capital gains potential high.
4. Can have a hands-off investment through a property management company.
5. Huge demand for property in certain areas, so smaller chance of void periods

Cons

1. Long-term strategy, so won’t feel true benefits if you want to sell quickly.
2. Potential for void periods if unable to find tenants.

2. Student Buy to Let 

Similar to residential buy-to-let, student buy-to-let is another strong contender for the best real estate investment.

Student buy to let is when you buy a property and rent it to students.

There are different types of student buy-to-let, including purpose-built student accommodation or a house of multiple occupancies (HMO).

The main benefits to student buy-to-let are that it is often the cheapest investment in property, with some of the highest yields.

RWinvest offers some of the most affordable student buy-to-let around, with prices from just £59,950 and returns of up to 8%.

Pros

1. Low property prices and high yields.
2. Earn income every month through rent.
3. High demand, with more students than ever studying in the UK.
4. Can make a completely hands-off investment.
5. Less risk of void periods with an HMO, as more than one tenant to cover costs if another defaults on payment.

Cons

1. Capital gains are not as high as with residential property.
2. Can only rent to one tenant group.
3. HMOs can have a lot of legislation attached to them.

Overall, for beginners, if you’re asking, “what type of property is best for an investment?” residential and student buy to let should be your main options.

Hopefully, you’ve now worked out what property type you want, and what area you want to invest in and are financially ready for an investment. Now, it’s time to actually invest.

There are two extremely popular ways of financing your investment, each coming with its own set of pros and cons.

Firstly, you can get a buy-to-let mortgage or a loan.

If you’re asking, “what is an investment property loan?” there are many options available, including a buy-to-let mortgage.

Buy-to-let mortgages are great if you can’t afford to buy a property upfront. With average house prices surpassing the £250,000 mark for the first time, the likelihood of investors being able to afford a lump cash sum as high as this is increasingly low.

This mortgage type is quite different from typical residential mortgages. They often command a higher deposit, typically 25%, and require you to earn over £25,000 a year.

Buy-to-let mortgages also usually can’t be used on off-plan properties, meaning you may be missing out on big savings if you rely on a buy-to-let mortgage.

Alternatively, you can invest through a property investment company.

Property investment companies are a great way to make savings on a property. They typically have excellent relationships with developers and, because of this, can offer massive savings on off-plan properties.

Likewise, they allow you to cherry-pick the best units in a new-build property, often located in thriving property areas.

Finally, they can even deliver assured rental returns, making the investment a lot safer than buying a property from an auction.

Whatever your decision, investing in real estate is a fantastic venture to consider and could net you a tremendous profit when done correctly.