What Is an Investment Property?
We all want to earn money.
Money is often the gateway to a happier life, with the ability to afford luxury items and holidays across the globe.
While many of us opt for the traditional route of working 9-5, others use their money differently and choose to invest.
Investing is an excellent strategy if you want to know how to generate passive income and become financially independent. By putting some finances into an asset, we can make huge gains and replace our primary income. It sounds great on paper, but is this reality?
Well, there’s a tonne of investment strategies out there that can genuinely net you huge gains when done right. One of these strategies is real estate.
Real estate is a fantastic way to earn money in 2021 and beyond, but it can be complicated with several things you need to consider before starting your investment journey.
In this guide, we will be discussing the ins and outs of real estate investment.
We will answer several key questions, including: What is an investment property? What is an investment property loan? What type of property is best for an investment? What is positive gearing an investment property? What is a good cap rate for an investment property and what is a good rental yield for an investment property?
What is an Investment Property?
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.
Why is Real Estate a Good Investment?
As an investment strategy, real estate is one of the most fruitful. Not only is the sector experiencing some of the highest growth levels in history at the moment, but you can also earn two types of income when you invest.
In real estate, you earn money through rental income and capital gains.
- Rental income: The money you earn monthly and yearly through rent.
- Capital gains: The increase in the price of the property over time.
This is what makes property investment so ideal. Not only can you earn consistent income every month for decades, but you can also sell the property after an extended period for a huge pay-out.
Let’s look at this in practical terms.
One city worth considering when looking for a real estate investment is Manchester.
The North West city has experienced some of the highest capital gains over the last two decades. It far surpasses the average growth levels in the UK.
At the turn of the century, property prices in Manchester were worth around £43,750. 20 years later, the average property is valued at £205,067 – a 368.7% increase in value.
Using the latest rent values from Zoopla, we can see that if you bought a property in Manchester in 2000, and sold it in 2021, you would have earned £284,160 in rent and £161,317 in capital gains – all while doing absolutely nothing for it.
This is real estate at its best – buying property at an affordable price and holding onto it for decades before selling.
You may think you’ve missed the boat for Manchester property, with prices already at the £200k mark. However, judging by how much prices have grown in 2021, and how much prices are expected to grow in the coming years, there’s still massive scope to make a huge investment.
Should I Invest in Real Estate in 2021?
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.
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.
Judging by how much prices have grown in 2021, and how much prices are expected to grow in the coming years, there’s still massive scope to make a huge investment.Daniel Williams, RWinvest
What Makes a Good Property Investment?
Different types of property have their own pros and cons. To understand what type of property is the right one for you, you’ll need to understand what makes a good investment first.
In property terms, a good investment is real estate that is affordable, has high market growth potential, high rental yield, and is located in an area with high rental demand.
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?”
Luxury M3 Investment
All-New Manchester Development
5% Projected NET Rental Return
City Centre Location
Salford Waterfront Apartments
Up to 6.5% Projected Rental Return
55% Below Market Value
Another vital aspect to consider before choosing your property type is rental demand.
Naturally, you will want as much demand as possible, so your properties constantly remain inhabited and earn you money.
Void periods (property not earning income due to no tenants) can be really damaging for an investor, especially if you have a buy to let mortgage or a loan to pay. Therefore, you will want an area with a strong renting demographic to make the best investment possible.
Perhaps the most important age group to consider, then, is young people.
Often referred to as generation rent, those aged between 18-40 often struggle to afford houses now due to hiking prices. Instead, they are increasingly renting as part of a lifestyle choice.
With that in mind, there are some obvious cities with a high population of young people, but that also offer high rental yields.
Two of the most popular options are Liverpool and Manchester. The cities have a combined student population of over 170,000, with 37% of the total city population between 18-34 in Manchester, and 42.3% of the population under 30 in Liverpool.
This has dramatically impacted rental demand, with a Zoopla report finding that the current ratio between supply and demand for property in Manchester is around 1:5.
These figures are good news for investors. It means they can make a substantial investment in residential and student property while drastically reducing the chance of void periods.
It’s not just rental yield and demand you need to consider, though. It’s also important to understand positive gearing and cap rate.
What Is Positive Gearing an Investment Property?
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.
What Is Negative Gearing in an Investment Property?
Negative gearing, or capital growth property, is when your monthly expenses on a property exceed the amount of rental income you are earning from tenants.
While this sounds bad, depending on your strategy, it may be incredibly fruitful. That’s because negatively geared investments are often expected to increase in value over time. These capital gains are expected to cover any short-term losses you experience.
Typically, though, most landlords will want positive gearing properties to remain financially stable. After all, if you lose a primary job, you will feel safe knowing your property is paying for itself.
Mortgage lenders will love positively geared property, as they will feel more confident lending cash if you can prove you can comfortably cover costs.Daniel Williams, RWinvest
What Is a Cap Rate?
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.
What Type of Property Is Best for an Investment?
With real estate, there are plenty of options to choose from when you want to invest. Each property investment strategy has a whole host of pros and cons. Here are some of the most popular strategies you can choose from.
Residential & Student Buy to Let Properties
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 £92,950 with returns of up to 8%.
- Easiest investment strategy to start with for beginners.
- Earn consistent income each month through rent.
- Massive predicted growth for the future, so capital gains potential high.
- Can have a hands-off investment through a property management company.
- Huge demand for property in certain areas, so smaller chance of void periods
- Long-term strategy, so won’t feel true benefits if you want to sell quickly.
- 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%.
- Low property prices and high yields.
- Earn income every month through rent.
- High demand, with more students than ever studying in the UK.
- Can make a completely hands-off investment.
- Less risk of void periods with an HMO, as more than one tenant to cover costs if another defaults on payment.
- Capital gains are not as high as with residential property.
- Can only rent to one tenant group.
- HMO’s can have a lot of legislation attached to them.
Commercial Buy to Let & Buy to Sell Properties
3. Commercial Buy to Let
Another form of buy to let, but not as popular as the previous two, commercial buy to let is a good choice if you want more security than other buy to lets.
Commercial buy to let is the idea of buying a property and renting it for use to a business or organisation.
- Longer lease lengths than residential buy to let.
- Commercial buy to let can have tax advantages.
- Economic uncertainty can impact commercial buy to let far more than residential buy to let.
- Finding tenants can be difficult if a business chooses to leave, resulting in more extended void periods.
4. Buy to Sell
One real estate strategy that may not have come to mind is buy to sell.
Buy to sell, or house flipping, is the process of purchasing a property to sell it quickly for a profit.
It can consist of renovating a cheap house and selling on for a profit or buying undervalued property and selling it instantly with no work.
This property strategy doesn’t involve renting out a property, so you won’t be earning any monthly income. Instead, you will be relying on your own skills and expertise in the property market to help make a profit in capital gains.
- Can make substantial capital gains on a short-term basis if you do it right.
- No need to deal with tenants and management.
- A hands-on method that requires a lot of skill and finances if you want to develop the property.
- If you can’t sell quickly, you may have to deal with paying mortgage fees with no income in rent to cover it.
- It can be incredibly expensive, with the potential for unforeseen problems arising during the development process.
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.
Fees to Consider
We’ve covered why you should invest in real estate, what makes a good investment, and what property types to consider. What’s next?
Well, before you start your investment journey, it’s important to consider monthly expenses.
Real estate isn’t just purchasing a property; there are several other fees you need to keep in mind to ensure you can afford the venture.
These fees can include solicitor fees, survey fees, insurance, stamp duty land tax, property management costs, and general maintenance and taxes.
It’s vital to do your homework before any venture and understand all these additional factors and costs.
If you want a deep dive into the property world and want to find out “how much money do you need to invest in property in the UK”, be sure to read our guide.
Luxury M3 Investment
All-New Manchester Development
5% Projected NET Rental Return
City Centre Location
Salford Waterfront Apartments
Up to 6.5% Projected Rental Return
55% Below Market Value
How to Invest
Hopefully, you’ve now worked out what property type you want, 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 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.
Don’t miss out and start your property investment journey today with RWinvest – the UK’s leading property investment company.Daniel Williams, RWinvest
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Disclaimer: This guide was made in March 2021. Figures mentioned about the property market are subject to change and may no longer be accurate when you read.