How to build a property portfolio

A quarterly series to help you get the most out of your money, presented with UBS Wealth Management. Steve Lodge's theme is bricks and mortar.

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Last Updated: 31 Aug 2010

The propery market has historically been the most popular, and frequently one of the most lucrative, of private investments for us Brits. Here, we consider what the future holds for buy-to-let landlords, and their more recent incarnation, jet-to-let landlords who own holiday homes abroad. We'll also discuss adding property to your pension portfolio, and the financial logic of giving your kids a leg-up onto the housing ladder, whether to earn you money or to get them out from under your feet.

Property investment in the UK has had a great run, with house prices doubling in the past five years. Landlords who put down a 25% deposit on a flat in 1999 - with the rent covering the mortgage - may have seen the value of their investment increase fourfold or more. As a result, the buy-to-let sector has boomed as more and more private investors choose to put their surplus cash into bricks 'n' mortar.

But rising house prices (not, for the most part, falling rents) have meant that the yields available to new landlords don't always cover mortgages and other costs, especially as mortgage interest rates have also risen on successive occasions, albeit from record low levels.

A rental property that costs a landlord money each month without the prospect of further big price rises to compensate is clearly a much less attractive proposition. This was reflected in the first recorded falls in new buy-to-let borrowing in the latter half of 2004.

The question for homeowners generally - rather than landlords in particular - is over the knock-on effect for the rest of the housing market. Will a loss of demand at the lower, buy-to-let end, with the accompanying possibility that existing landlords could also cut and run, be the catalyst for price falls in the wider market? Mortgage industry experts have been keen to play down such fears, emphasising that although buy-to-let may be set for slower growth in the short term, landlords will mostly stick with the properties they have for the long term.

Recent research by the Association of Residential Letting Agents found that on average landlords expect to keep properties for more than 15 years, and have already been in the market for more than four years. 'Clearly there are some amateurs, but there are also a lot of professionals,' says Ray Boulger, senior technical manager of mortgage brokers Charcol.

Research for Charcol suggests that another 300,000 properties will be bought to let out over the next decade. A range of socio-economic factors will fuel this growth, including a shortage of properties for purchase, older first-time buyers, increases in the number of single-person households and students, and more competitive mortgage lending.

One of the biggest triggers for renewed market activity is expected to be the ability to put buy-to-let property in a pension from April 2006 - offering upfront tax relief of 40%, as well as tax-free profits and rental income. Estimates suggest that more than £10 billion of property will be bought through pensions and - thanks to the tax perks - a possible doubling of profits from buy-to-lets outside pensions.

But with property values now seemingly in reverse, this may well also be the biggest year yet for Brits buying abroad. Having made good money here, many investors are now keen to try the same trick in another country, where the pickings may be richer. 'There's been a significant increase in buying abroad,' says Boulger.

Liam Bailey, head of residential research at international estate agent Knight Frank, agrees: 'Buying abroad is the logical next step for many buy-to-let investors, having chased the growth round the UK, they have become more confident and speculative.' Knight Frank predicts that foreign property ownership will increase by an average of 10% a year for the next decade from a current base of 200,000 UK households.

As with buy-to-let, disenchantment with traditional pensions and stock market investment is likely to be a key driver. Overseas property can also be held in pensions from next April, although there may well be tax complications.

For many though, buying abroad will be primarily a lifestyle rather than an investment decision. The idea of retiring abroad to a warmer, more relaxed, cheaper lifestyle holds wide appeal. Low-cost flights across Europe improve access and reduce journey times to holiday-home destinations, while technology is making remote working a reality.

Property prices are generally lower than in the UK, with some agents talking about 'dream homes for average (UK) prices', while in new markets such as Bulgaria 'you can almost put properties on your credit card', according to Miranda John of mortgage brokers Propertyfinance4less. Buying power has been boosted by the strengthening pound and the growing availability of low-cost mortgages: Brits can borrow in euros at just 3% or so and even less in US dollars, according to Conti Financial Services, a long-established foreign currency mortgage broker.

But getting carried away with the dream of living abroad is just one of the many risks. While UK property prices have grown faster than those of most of Europe since the mid-90s, France and Spain have experienced bigger increases lately. Last year, prices rose by more than 15% in these countries, compared with 12% in Britain, according to the European Housing Review from the Royal Institution of Chartered Surveyors (RICS). Knight Frank believes holiday homeowners in popular parts of France and southern Spain could easily have seen prices double in the past five years. The US (where the weak dollar is attracting more interest from British property buyers) and Australia have also enjoyed property booms in recent years.

Says Michael Ball, author of the RICS study and professor of property economics at Reading University: 'Many people have done very well, but it's more risky to buy now. Prices are over trend - though no more overblown (than) in the UK. There is a feeling that some markets have peaked, and some countries clearly have unsustainable house-price growth rates.'

Ball warns that the discretionary nature of holiday homes means that markets are more volatile. And just as house-price growth in the UK slowed last year as interest rates rose, European housing markets, he believes, are also susceptible to rising interest rates. Rates in the eurozone are widely expected to rise.

Price rises in traditional European sunspots have been encouraging interest in cheaper eastern European destinations such as Croatia and Bulgaria. But what seems cheap to you could be a rip-off price by local standards. 'A few tens of thousands of euros is still a fortune in Bulgaria,' notes Simon Conn, senior partner at Conti Financial Services.

Prospective landlords looking at high rental yields in new markets do not always consider how seasonal the market is, he says, and ensuring proper title is key. Conti emphasises the need to get professional advice (see panel opposite) and not to underestimate the additional complications of buying abroad. Researching prices, areas and letting markets is just as vital as in the UK, if not more so. And make sure you understand the purchase processes and legal and administrative peculiarities of your chosen country. The possibility of changes in tax treatments and laws such as the infamous Spanish 'land grab' should also be serious concerns.

'Having got experience in buy-to-let, a lot of people are now making mistakes abroad,' observes Conn - buying after meeting a guy in a bar or letting hearts rule heads. Whatever you do, don't be impulsive. If a deal seems too good to be true, it probably is.

Cash purchases, from remortgaging a UK property or other means, are generally the cheapest and quickest way to buy abroad, but can also be the riskiest.

By contrast, an overseas lender will do its own survey and legal checks, providing extra reassurance. Having a local-currency mortgage can offer protection against exchange rate fluctuations. If you have a sterling mortgage, you could find a gain in the value of the property offset by a fall in the value of the currency. If the mortgage is in the local currency, the cost of the loan in pounds will also fall. In addition, if you receive rental income in local currency, it can be used to pay the mortgage without an exchange rate risk.

Euro and US dollar mortgages are cheaper than sterling rates, although arrangement fees of about 1% tend to be higher. Brokers may also charge up to another 1.5% to arrange foreign mortgages. And don't dismiss sterling loans out of hand - they can protect you against a strengthening local currency requiring higher payments.

Buying a foreign property is unlikely to provide a way to avoid inheritance tax (IHT), says Simon Rees, senior manager, private clients at PwC. For most people, the fact that an asset is abroad will make no difference to UK inheritance tax liabilities. And Brits might even face additional local wealth or inheritance taxes.

Pension rule changes from next April might offer the chance to pass on properties free of IHT through a 'family SIPP (self-invested personal pension)', but many experts predict that such loopholes will be swiftly closed. Similarly, corporate structures that have long been popular and tax-efficient ways of buying property abroad face more tax complications. 'Don't have a company structure just because everyone else does,' advises Rees.

Allowing investment hopes to cloud your thinking can be dangerous, experts warn, just as assuming that property that is cheap by UK standards is a bargain. 'Second homes should be cheaper,' points out Ball. An overseas holiday home bought with an eye on retiring and let out in the meantime to cover some of the costs is a different investment proposition from a buy-to-let property in the UK, where the aim is to have tenants continuously. Will you get enough use from the property to justify the expense and commitment? Will you be happy going to the same place on holiday year after year? The cost and aggro of security and maintenance will almost certainly be more then you expect, and there's always the chance that the cheap flights to your nearest airport will be withdrawn, with dire consequences for the local holiday market. 'The further away from the property you are, the more risky it is,' says Ball. 'A very nice hotel is usually a lot cheaper than a second home.'

BEST OF BRITISH LUCK - BUYERS ABROAD BEWARE

- Get an English-speaking lawyer who is independent of the vendor and well versed in local property laws and processes. Don't let salespeople talk you out of using your own lawyer.

- Never sign a contract that you do not understand (for example, if it is in a foreign language). Read all the small print - and get your lawyer to explain it to you. Don't sign anything or hand over money until your lawyer tells you to.

- Get an independent valuation, which should point out problems such as subsidence, damp and wiring defects, and might also highlight any boundary disputes.

- If you are arranging finance on the property, ensure that this is stated in any contract and that you have an opt-out clause if the loan is not agreed (to ensure any deposit is refunded).

- Always give yourself a cooling-off period if you are tempted or pressured into putting down a cash deposit immediately.

- Allow for higher transaction costs than in the UK: legal fees and taxes can amount to more than 10% of the purchase price.

- Open a local bank account and ensure you get a certificate of importation for money that you bring in.

- Set up standing orders locally to meet bills and taxes. Failing to pay taxes in some countries could lead to court action and possible seizure of your property.

- Get clear answers to the following 10 questions (through your lawyer if necessary), and think hard about proceeding if any answers are unsatisfactory:

1. What are the property boundaries?

2. Is there an up-to-date entry in the local land registry?

3. Is the seller the rightful owner? (get documentary evidence)

4. Will you be able to make structural alterations and use the property

as you wish (eg, rent it out)?

5. Is the property connected to the utilities - if not, how much will it

cost to get connected up?

6. Is the price in the contract the one you agreed on?

7. Confirm that you will not inherit a debt on the property: if money

has been borrowed to build a development, an amount may have been

allocated against each plot as security to the developer's bank.

8. Does the contract guarantee you vacant possession on completion?

9. Is it clear who is paying the agent's commission?

10. What local taxes will you be liable for?

SOURCES: Conti Financial Services; Propertyfinance4less.

CASE STUDY - CHAMPAGNE LIFESTYLE

The 'phenomenal disparity' in property prices between France and the UK was part of the attraction of the 1830s Manoir de Maffrecourt in the Champagne-Ardennes countryside of north-eastern France. Grant and Sandra Endersby bought the house, set in five acres of land, for EUR185,000 in April 2004 with the aim of moving to France and running a high-end holiday lettings business.

Having invested more than EUR100,000 in renovations, the manoir's value is now estimated at about EUR450,000. An English surveyor put the price of the equivalent property in Kent at £1.5 million. The Endersbys say the local property market is relatively stable. 'Prices haven't gone up a lot round here because there aren't a lot of Brits.'

The house has seven bedrooms and offers self-contained apartments - gites. 'We wanted to have our cake and eat it,' says Grant. Both are in their forties and were looking for a better quality of life. Grant also continues to run a 'less customer facing' website development business.

Their new lettings venture is in marked contrast to a previous buy-to-let in Hertfordshire, which they sold in 2001. It made a 50% capital profit in five years and the rent covered the mortgage. 'It was a nice, tidy deal with one good tenant,' he says.

By contrast, the holiday lettings business involves big seasonal peaks and troughs, with clients staying a few weeks at most, and plenty of competition for tourists of many different nationalities. Grant and Sandra are hoping for 70% to 80% occupancy in year three or four. 'But at worst we hope to cover our costs,' he says, 'and we plan to die here.'

His top tip for buying abroad? Get a good lawyer, mortgage broker and other advisers. 'We couldn't imagine doing it without advice,' he says.

DO WELL BY YOUR CHILDREN

The housing boom has transformed the wealth of many Britons but made it much harder for first-time buyers to get on the property ladder. Many parents are therefore having to help their children become homeowners.

Ray Boulger of mortgage broker Charcol says the most common type of financial assistance is with the deposit. Having a sizeable one (the average required is now £26,500, or £48,000 in London) is vital if many first-time buyers are to bridge the gap between what they can borrow and sky-high property prices. The most competitive deals tend to require a minimum deposit of 10% of the purchase price.

Having a decent deposit can give access to lower rates and avoid higher lending fees, as well as reducing the monthly mortgage bill. And so long as the parents live another seven years, such gifts are free of inheritance tax. Even if the money is regarded as a loan, it shouldn't normally restrict how big a mortgage the son or daughter can get on the basis of their own income.

Parents can also become guarantors for a mortgage, enabling their child to borrow more. This involves becoming jointly liable for the loan without making you a part-owner of the property - so avoiding capital gains or inheritance tax complications.

But if you still have a mortgage on your own home, beware. Most lenders will require the guarantor to have enough income to cover both their own mortgage and that of the child, based on a lender's normal loan-to-income limits, says Boulger. And as guarantor, you'll be liable if your child defaults.

Buying a property and letting children live there is another option. Parents may take the view that as they will often be paying for the child's student living, doing so could be a way of saving on higher education costs. Student properties can make good investments, so you could make money on resale.

But you are not directly helping your children onto the housing ladder, and you could also be creating future capital gains and inheritance tax bills. If, instead, the property is an outright gift, then after seven years it is entirely free of inheritance tax.

If you don't fancy gifting away such a large asset, set up ownership on a tenants-in-common basis, with you as parents owning just 1%. This is tax-efficient and gives you some say in the eventual fate of the property.

The mortgage industry continues to find ways of appealing to the parents market. Family offset loans allow parents to forgo interest on savings in return for a reduction in their child's mortgage payments. This is also tax-efficient, as the tax on saving interest helps to reduce the loan costs.

Older parents who have paid off their own mortgages might consider releasing equity from their homes to help, potentially also reducing future inheritance tax liabilities. Equity-release or lifetime mortgages are available for the 60-plus age group, but beware - the same tax benefit can be achieved more cheaply through mainstream mortgages.

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