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Is residential property a good investment?

Over the last ten years owners of residential property have benefitted from rental income above the returns available from deposit based investments.

In addition to good rental income levels, landlords have also enjoyed a substantial increase in the value of residential property generally.

According to the Nationwide house price index the average property price has increased by over 99% from the end of 2000 to the first quarter of 2010.

There are many advantages to owning residential property, including the feeling of ownership, the possibility of increases in the value of the property, the rental income along with the ability to offset certain costs towards the property purchase and up keep.

However as with any investment there are potential drawbacks. Property prices can be low and can in fact fall as we have seen over the last few years. The Nationwide HPI showed average property prices only increased by 3.4% over the last five years.

If a mortgage is used to purchase part of the property then increases in interest rates can affect the ultimate return. Most landlords will experience void periods, when the property is not rented. Bad tenants can also affect the return if damage or non payment of rent occurs.

Apart from these advantages and disadvantages there are a few other points that investors need to consider.

Residential property is an ill-liquid asset and cannot be quickly or easily sold. If property prices are depressed investors may find they either cannot or are un-willing to sell at that point.

Taxation. Second properties are usually subject to capital gains tax. This should be borne in mind when considering an investment. With the current budget deficit, CGT will almost certainly increase. We could see CGT increase from 18% to 40%.

Residential property cannot easily be used for inheritance tax planning.

For example

• Property Valued at 150,000 in Dec 2005
• Rental income 700 gross per month (11months rent per year to take into account void periods.)
• Investor is a higher rate taxpayer
• Cost in maintenance assumed £400 p.a
• Property sold 5 years after investment made.

Property price in Q1 2010* £155,235

Rental income £38,500

Maintenance costs £2,000

Net rental Inc after tax and costs £21,900

No CGT as growth below allowance

Total net return £177,135

Total return over 5 years 18%

Annual rate of return 3.38%

*Nationwide House price index as at June 2010.

Investors may wish to hold property till death and avoid CGT however depending on circumstances the investors estates could then be subject to inheritance tax.

The value of property and rental income is not guaranteed. Values can fall as well as rise. You may not get back the amount you initially invested. This article should not be construed as giving advice.

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Consilium Asset Management Ltd is authorised and regulated by the Financial Services Authority. FSA no 469507.