View all articles
Properties can make a fantastic investment. As an asset class, they have a long list of attractive characteristics. Whether it is their tangible nature, long-term track record, income production, or ability to utilise leverage, there is certainly something of appeal for everyone. However, property investment does come with one glaring barrier to entry: significant start-up costs.
Whilst there are properties in undesirable locations which can be purchased for sub £50,000, such properties tend to be priced cheaply for a reason. They may not be mortgageable or may be in an area experiencing a substantial decline. The unfortunate truth is that investors will need to pay £80,000 – £100,000 at the very least to access entry-level investment properties. Even with leverage, this requires a £20,000 deposit plus costs. This figure rises immeasurably for people looking to invest in the South or city-centre locations.
As a result, start-up costs are one of the key barriers to entry for property investment. As the saying goes, you need money to make money. For many would-be landlords with aspirations of financial freedom, this is the frustrating reality of property investment. It also begs the question, are there other ways to invest in property without needing £20,000 and how can you put your money to work while you save up for your next deposit?
What Are Real Estate Investment Trusts (REITs)?
One way of investing in property without needing substantial start-up capital is to invest in REITs (Real Estate Investment Trusts). REITs are companies that own and operate income-producing property on behalf of their investors. They provide a way for investors to access the risks and rewards of holding property assets without having to buy the property directly.
To be classified as a REIT, a company must comply with certain rules:
- 75% of the company’s profit must be generated from rental income.
- 75% of the company’s assets must be properties available to rent.
- 90% of the company’s rental profit must be paid out to shareholders.
Advantages of Investing in REITs
Investing in REITs comes with a number of inherent advantages for would-be landlords. These include:
- Lower capital costs compared to property investment
- Liquidity
- Reliable income
- Diversification
- Broader opportunities
- Relatable knowledge
Minimal Capital Outlay
As a landlord, one of the most appealing aspects of investing in REITs is that they give you exposure to the property market without requiring an initial capital outlay of £20,000 or more. Much like stocks and shares, REITs can be bought and sold on an investment exchange, with each individual share accounting for a relatively small capital outlay. This means that would-be landlords and those building up savings for their next deposit can put their money to work in the property market, irrespective of the amount that they have to invest.
REITs are More Liquid in Nature
As REITs are traded on investment exchanges, they have an inherent characteristic that typical property purchases do not, liquidity. That is, REITs can be quickly and easily bought or sold in the market without affecting the asset price. If for one reason or another, you wanted to purchase or sell a property immediately, you would likely have to pay a significant premium or accept a significant discount accordingly. However, should you manage to build up a deposit and finally find a property which you wish to invest in, your holdings in REITs can be sold almost instantaneously, freeing up your capital.
REITs Generate a Return
It’s all well and good highlighting that investing in REITs is a quick and relatively easy transaction to make, however the biggest rationale for investing in REITs is that they generate returns. Much like purchasing a property outright, REITs have a portfolio of properties which produce consistent returns to shareholders. UK REITs are required to return 90% of their taxable income to shareholders, which is paid as rental income as opposed to dividends. This can provide investors and landlords with a high-yielding return, allowing landlords to build up the capital for their next deposit even faster.
REITs are More Diversified
REITs also allow landlords to diversify their investments somewhat. Much as the saying ‘don’t put all of your eggs in one basket’ holds true, it makes sense not to invest all of your money into one property on one street. Diversification allows investors and landlords to avoid the risks of picking a ‘loser’ or investing poorly, while also increasing the likelihood of having a ‘winner’ within your portfolio. Investing your savings into REITs allows you to own a share of hundreds, if not thousands, of individual properties throughout multiple locations. This helps to diversify your income and reduce risk.
The vast majority of landlords invest in residential real estate, a large proportion of which is single-occupant buy-to-let. REITs afford landlords the opportunity to venture out of their comfort zone and invest in non-vanilla property. REITs tend to specialise in a variety of different property related areas, be it commercial property, industrial estates or social housing. Landlords have an opportunity to expand their horizons and diversify their portfolio by investing in property holdings which they would not normally purchase outright.
REITs Can Help Improve Your Property Investment Strategies
Finally, it is important to research and consider the best REIT for you. This entails understanding the markets in which they operate in and reading their annual reports and publications. Admittedly, this might not be the most riveting task for many people, but it is not without purpose. Reading into and understanding different REITs can be a valuable font of knowledge for investors. REIT managers are seasoned property investors with a deep understanding of the market and their asset class. Reading their thoughts and their investment strategies can only be of benefit to traditional or would-be landlords and can help to refine and develop your own property investment frameworks.
Risk of Investing in REITs
Much like investing in individual properties, investing in REITs does come with a degree of risk. Investing in bricks and mortar has proved to be a phenomenally good choice historically, however it does not come without short term risks. There is always the risk that the property market may crash, which would affect both individual properties and REITs alike. Equally, there is the risk that you may opt for a poorly performing or overvalued REIT which may hamper your returns. That being said, these risks are no different to any other type of investment and can be mitigated somewhat by being disciplined and considering the following rules:
- Don’t overpay for REITs (i.e., those with a price-to-book ratio of over 1.2x)
- Avoid overly indebted REITs (those with a loan-to-value of more than 40%)
- Research, research and research some more, make sure you have a rationale and reason for investing in the REITs you choose
How to Value REITs
This article is not intended to be an in-depth exposition on how to make millions from REITs. However, it is worthwhile to know the key metrics that help investors to assess the value of such trusts:
1. Price To Book Ratio
Perhaps one of the most important measures when evaluating a REIT, the price-to-book ratio gives an indication of whether you are under paying or overpaying for the assets which the trust holds. The price-to-book ratio can be worked out as follows:
Price to Book Ratio = Share Price / Net Asset Value Per Share
If the REIT were to sell every property and repay all outstanding debt, then they would be left with the Net Asset Value. If you held 1% of all outstanding shares in the REIT, then you would be entitled to 1% of the Net Asset Value.
Effectively, if a REIT were to have a price-to-book ratio of one, then purchasing a share for £1 would give you a proportional share of £1 in assets. A price-to-book ratio of less than one would indicate that you are paying less for an asset than its theoretically worth. Conversely, a price-to-book ratio of more than one would indicate that you are paying more per share than the assets are worth. The caveat being that the market tends to price in risk and reward accordingly, so a price-to-book ratio of less than one does not necessarily indicate great value.
2. Dividend Yield of REITs
Fundamentally, the dividend yield of a REIT is an expression of your current rental return. If you were to invest £100 into a REIT which returned a dividend yield of 5%, then you would receive an annual income of £5.
In theory, the higher the dividend, the better the return. However, it is worth noting that dividends can vary over time and disproportionately high dividends may be a sign of the market pricing in a decreasing return in the future. Given that REITs are required to pay out 90% of their taxable profit, any fluctuations to their rent or performance will immediately feed through into the dividend yield.
3. REIT Loan To Value
One of the big advantages of investing in property is the accessibility and relative cheapness of borrowing. Borrowing allows property owners to afford properties they otherwise couldn’t and to turbo charge their returns. Much like typical buy-to-let investments, many REITs will publish their Loan-To-Values (LTVs) to demonstrate how much they have borrowed relative to their portfolio.
The higher a REIT’s loan-to-value ratio, the more indebted they are and the more exposed the trust is to movements in the interest rate. Higher loan-to-value ratios indicate a greater degree of risk.
4. Operating Margin
Unlike typical investment funds which charge an annual fee, REITs tend not to charge an ongoing fixed rate to manage your money. However, REITs do still have administration costs such as office expenses, management salaries, financing costs and property management fees. These costs are deducted from revenues, with 90% or more of the remainder being paid out to shareholders.
It is worthwhile to look at the operating margin (annual profits divided by the annual revenues) to determine how costly the portfolio is to operate and whether it truly indicates good value.
Some REITs To Consider
At the latest count, there are over 480 publicly listed REITs available globally, with nearly 50 in the UK alone. Filtering these down to find the best is no easy task and it is not the place of this article to recommend the best REITs, however it is worth highlighting the sheer breadth of REITs available to erstwhile investors:
SPDR Dow Jones REIT
For landlords seeking to diversify or invest internationally, it may be worth considering a REIT with holdings ‘across the pond’. The SPDR Dow Jones REIT does not confer a share in a single US property investment trust. Rather, it provides investors with access to a diversified basket of multiple US REITs across the commercial, residential and retail markets.
The benefit of this REIT is that it provides a very well diversified exposure to a non-UK market. Investors are effectively speculating that the US property market will continue to grow and remain stable for as long as they hold the shares.
Sabra Health Care REIT
Perhaps you want to focus in on a more specific area of the market. The Sabra Health Care REIT focuses on both large and small scale healthcare properties throughout North America. The portfolio consists of more than 425 properties across both the US and Canada. The majority of which are nursing homes and transitional care centres, with some additional holdings in senior housing and speciality hospitals.
Historically, healthcare related properties have been a stable source of income. Hospitals and nursing homes don’t tend to uproot or go bankrupt overnight. As such, they tend to provide a long-term source of income and require little in the way of active management. Whilst such a REIT is unlikely to make you a millionaire overnight, it could certainly be considered a relatively safe place to park your cash.
Tritax Big Box REIT
Tritax Big Box REIT has a diverse portfolio of supply chain units, warehouses and distribution centres. It serves a broad portfolio of tenants, including Rolls-Royce, DHL, Next, Tesco, Morrisons and M&S. What is more, many of these multi-billion-pound companies have signed up to long-term lease agreements, providing Tritax Big Box with a selection of long, stable leases with relatively secure incomes.
NewRiver REIT
The NewRiver REIT specialises in UK-based commercial properties, with a focus on shopping centres and retail parks. Their portfolio spans 8 million sq ft and comprises 33 community shopping centres and 19 retail parks throughout the UK. Given that the portfolio is focused on large retail developments, the company has a broad range of high-street brands, ranging from Poundland, to TK Maxx, Subway and Argos.
Triple Point Social Housing REIT
Triple Point develop and lease social housing properties throughout the UK, with a focus on specialised supported housing. Their aim is to provide long-term, high quality, adapted housing for people with care needs. The company has a portfolio of 458 Supported Housing properties (3,214 units) across the UK, worth over £500mn.
Custodian REIT
Custodian has a £500mn portfolio of properties throughout the UK, with a broad mix of commercial and industrial properties. The aim of the fund is to provide a highly diversified exposure to non-residential UK property, with no one sector or geographic region accounting for more than 50% of the portfolio and no property or tenant accounting for more than 10% of all rents. What is more, the trust avoids large scale purchases, with their target properties typically being worth between £2-10 million.
Disclaimer: This ‘Landlord Vision’ blog post is produced for general guidance only, and professional advice should be sought before any decision is made. Nothing in this post should be construed as the giving of advice. Individual circumstances can vary and therefore no responsibility can be accepted by the contributors or the publisher, Landlord Vision Ltd, for any action taken, or any decision made to refrain from action, by any readers of this post. All rights reserved. No part of this post may be reproduced or transmitted in any form or by any means. To the fullest extent permitted by law, the contributors and Landlord Vision do not accept liability for any direct, indirect, special, consequential or other losses or damages of whatsoever kind arising from using this post.
