Understanding different types of property investment

Property ownership is much more of an obsession for the British than other European nations and it goes beyond simply owning one’s own home; property investment is a favoured means of generating passive income and building wealth in the UK.

Traditionally, most people have been exposed to residential property, but commercial property and property development also offer unique opportunities. In understanding the differences between these, it's essential to evaluate the risks and benefits associated with each type.

Residential

Residential property pertains to homes: houses, flats, apartments, and other dwellings. Many investors are drawn to residential property because of the relative familiarity and the perennial demand for housing. With the right property in a good location, landlords can anticipate a consistent monthly rental income. In addition, there is the capital appreciation: historically, house prices have generally risen over the long term, especially in sought-after locations. This allows investors to benefit from both rental income and the appreciation of their asset.

Furthermore, as a physical entity, a property is an asset that can be improved or modified, potentially adding to its value.

The risks associated with residential property investment are void periods, repairs, and borrowing costs. Without tenants, a property can quickly become a liability. This can be due to various reasons, from local economic downturns to issues with the property itself. All properties require upkeep, which can occasionally include unexpected and costly repairs.

Those using mortgages to invest in property are susceptible to interest rate fluctuations, which can influence the cost of borrowings and potentially squeeze profit margins. This has been the case for the past two years, and as a consequence many ‘amateur’ landlords have exited the market.

Commercial

Commercial properties encompass offices, retail spaces, warehouses, and industrial units. They operate differently from the residential market and thus attract different kinds of investors.

The benefits can differ from those from residential investments. Commercial tenants often sign longer leases, sometimes spanning multiple years. This can secure a consistent revenue stream for the investor for a more extended period. Also, due to the nature of business, some commercial properties can command higher rents, especially in prime locations.

There is also the fact that commercial leases can sometimes place the responsibility of maintenance or repairs on the tenant rather than the landlord, depending on the agreement.

On the risk side of the equation, commercial properties can require a more substantial outlay of capital to acquire than most residential properties. In addition, the profitability of commercial tenants can be closely tied to the economy. An economic downturn can result in business failures, translating to property vacancies. There is also the fact that commercial property agreements can be complicated, potentially leading to disputes if not appropriately managed.

Property Development

Buying land or property, making improvements or developments, and then selling it on, for a profit, is the remit of the property developer, and can range from minor refurbishments to major construction projects. If executed correctly, development projects can offer substantial returns on investment, often in shorter time frames than traditional property investment.

Of course, projects are inherently riskier, as they are subject to planning permissions, construction issues, and market demand upon completion. These projects can also require substantial funds, both initially and throughout the development process, and during periods of high inflation, rising costs can seriously damage profit margins. Meanwhile, if the market declines during the development phase, investors may struggle to recoup their investments.

Financing

Different types of property investment require different forms of financing; namely buy-to-let mortgages for residential investments, commercial mortgages for commercial investments, and development finance for property development. Lenders will want to establish that those looking to rent out their property, whether residential or commercial, have done their research and can show adequate demand for their property, as well as being able to comfortably cover void periods.

With development finance, lenders want developers to have a thorough plan, detailing realistic costs and timings, and showing the ability to overcome any unexpected delays and/or costs increases. In addition, having more than one exit strategy will reassure lenders that there is a ‘plan b’ if the preferred way of repaying the loan becomes unviable for some reason.

In conclusion, while all three property investment avenues offer attractive opportunities, they each come with distinct risks and benefits. Potential investors should thoroughly research and possibly seek expert advice before committing capital, ensuring that their choice aligns with their financial goals and risk tolerance.

Elena Panayiotou, Loan Officer at London Credit