Property - investment fund or buy to let?

If you have been thinking about dabbling in the buy to let market but are nervous about the entry costs and possible voids in rental income (periods when the property is empty and you aren't earning) you may find that property investment funds are an easier way to invest.

Now that commercial property investment funds can be included in an Individual Savings Account (ISA), several new property funds have been appearing on the financial landscape and you can start one from as little as £50 a month or a lump sum of £1,000. With buy to let you have the usual house buying costs including solicitors fees, surveyors fees, stamp duty, furniture costs and then possibly capital gains tax when you sell. None of these apply to a property fund.

However, don't think there won't be fees with property investment funds - there is an initial charge often up to 5% plus an annual management fee of around 1.5%. The main advantage with property funds is that you can get your money back quickly if you need to sell, whereas property it can take a long time to sell.

The returns on property investment funds have been soaring, reaching around 18% over the past few years while annual returns on buy to let are now around 6.45%; you can see why investors are expected to put billions of ISA investments into commercial property this year. You may invest up to £7,000 into a stocks and shares ISA each tax year or, if you hold a £3,000 mini cash ISA, up to £4,000 in a mini stocks and shares ISA.

With a buy to let property you are investing in residential property (remember you are already exposed to the vicissitudes of the housing market); the new property funds offer you access to investment in commercial property (previously effectively out of reach to the individual).

All financial experts recommend that you do not place all your investments in one asset class. Going into buy to let could mean you are over-exposed to the residential property market whereas with a property investment you spread the risk over a number of commercial property types and, depending on the fund, different countries as well.

You have two ways of investing in commercial property. Either one invests directly in a property such as offices, retail outlets, factories and leisure developments or in securities, that is the shares of the companies doing the building work.

Property funds allow you to benefit from the rental income and from an increase in the value of the property. The advantage of commercial rental leases is that they tend to be longer than residential leases and have what are known as "upwards only" rental reviews built in. Because the rental income tends to be more stable than equities, investors may want to look to have commercial property in abalanced portfolio to help them smooth out the more volatile equity markets.

In fact, commercial property has outperformed equities and bonds over the past decade although financial analysts don't expects this outperformance to continue.

Among property funds worth a look, the Fidelity Global Property Fund, launched in January, is an equity product investing in between 50 and 70 stocks and in Real Estate Investment Trusts (made up of residential and commercial property) from all around the world. You can start investing from £50 a month. Fidelity expects this to provide an annual gross return of between 7% and 9%.

Scottish Widows' Investment Partnership puts its funds in commercial property such as warehouses, offices and out-of-town retail parks in a cross section of regions across the UK. In the first year of its launch in November 2004, the unit trust produced a return of 18.48% and now holds funds of £801.4 million up from £600 million at its launch. You need £5,000 to start an investment in this fund.

The Legal & General UK Property Unit Trust, launched in February, is available to customers as an ISA, for ISA and PEP transfers and for direct investments into the unit trust. Minimum investment is £50 per month for regular investments and £500 for lump sum.

While the returns on commercial property have been phenomenal in the past, the trick is to choose the right fund. The same is true when choosing a property - you have to pick the right one. Buy to let investors have in the past banked on most of their return coming from an increase in the capital value of the property but with house prices moving at a slower rate, the potential return begins to look less attractive. It is a question of doing your homework and buying a rentable property that will grow in value. Make a mistake and buy the wrong property and not only will you get lower rents or no rent at all, it will take a longer time to make a profit when you sell.

Nevertheless, confidence has been returning to the buy to let market. Residential rents from buy to let rose to 6.45% in January from 6.42% in December, according to Paragon Mortgages. Lending rose by 39% in the last six month of 2005 to £14.6 billion, 47% higher than the first six months of the year. Mortgage Express expects demand for rental properties to increase by 3% a year over the next ten years due to social and demographic trends with more young people renting for longer periods while they save for their first home.

08 March 2006 © Moneyextra.com

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