The evidence surrounding performance of UK residential property investment is contradictory: even headline-grabbing surveys, such as the Nat...

The evidence surrounding performance of UK residential property investment is contradictory: even headline-grabbing surveys, such as the Nationwide, Halifax and ODPM reports, frequently fail to agree over the short-term future of the market. Similarly, the long-term future seems equally unclear, with many a doomsayer over the past few years having predicted an imminent crash, which of course has not materialised. So why would today’s investors be tempted to go back for more, and is the current increased interest in residential property investment a sign of little more than the irrationality of markets? I would argue not. The underlying supply-side issues which have dogged the UK housing market for decades dictate that there is a huge and sustainable long-term demand for property. While monthly and quarterly reports announce blips and booms, the long-term picture is of a massive, unsatisfied demand for homes. This growing demand comes from factors beyond the simple boom and bust parameters of speculators. In the UK we are marrying later, are more likely to divorce, or live alone, and the workforce is increasingly transient. It is notable that even though the recent rate rise may have caused a slight dampening of appetite amongst buyers, house prices were not affected, as the rise was outweighed by a significant shortage of stock and generally high levels of demand which bolstered prices. In London, the capital’s population has grown by 600,000 (the size of Sheffield) since 1989, and will grow by a further 700,000 (the population of Leeds) by 2016. There are other parts of the country where demographic factors and the nation’s planning system dictate that for years to come, demand will massively outstrip supply. Furthermore, debt in this asset class remains cheap because lenders regard property as a safe investment. They have done their homework and see that sustainable long-term demand and shortage of supply are underpinning the market and driving long term gains. This low risk premium reflects property’s low volatility. While equities offer liquidity and the apparent security of a regulated and transparent market, they remain much more volatile than residential property. UK equities have failed to recover the pre-crash losses of 1999, remaining 12 per cent below prices of 6 years ago. Conversely, there have been just 4 out of the past 50 years in which UK property prices have fallen, and there is a 100 per cent record of price recovery in that time. The low price of debt is further leveraged by the fact that property is a geared investment, a fact that is too often forgotten when even the most basic comparison of investment returns are made. Gearing of 75 per cent is typical, and looking at the performance of geared investments compared to FTSE 100 performance, the advantages are self-evident. £75,000 invested 20 years ago in the FTSE would realise £300,000 today, while the same sum would have returned an impressive £1.136 million in geared UK residential property. Finally, there remain numerous tax advantages in holding property in the UK, such as taper relief, the ability to reinvest capital gains in property free of CGT, offsetting running costs against incomes and those advantages afforded to offshore investors. While an investor should consult their professional advisor in order to maximise tax advantages to their personal circumstances, the UK regime can be surprisingly investor-friendly in this sector. Direct Versus Indirect Investment But this still leaves even the property investment convert with a dilemma: should the strategy be one of direct residential property investment, or should the approach be indirect? One should be absolutely aware that in terms of behaviour and returns, property funds are radically different to direct investments, and the unequivocal conclusion is that a property fund loses a great many of the benefits of direct property investment. The most significant loss is that of control: whilst unit trusts and other fund types do hold a spread of property, the investor has no direct control over where, or how, their funds are allocated. Specific intelligence about an area, whether it be demographic information or awareness of pending infrastructure changes which may increase demand for property, is rendered irrelevant. Along with many others, I remain sceptical about the liquidity of funds. While some may be readily liquidated, this does not always hold true and in many cases, fees are excessive, eating heavily into returns. Funds are subject to charges based on a percentage of the value of the holding, and can eat significantly into the yield. And, of course, like any fund, property funds are sensitive to the potential departure of the fund manager. Most fundamentally of all, property funds are a different animal to property. Incisive Research recently showed, for most investors, the reason for investing in property funds was essentially defensive: the main motivation for investing in funds as opposed to other assets was diversification, which achieved an importance ranking of 72 out of 100, followed by lower volatility at 69, and non-correlation with other assets in third place at 67. In contrast, direct property investment avoids the aforementioned loss of control, carries far lower charges (as a percentage of return), and is not subject to the vagaries of departing staff. Of course, direct property investments are not as liquid as some alternatives. But unlike some funds, they are transparently less liquid, enabling a clear and premeditated exit strategy to be put in place. In conclusion, the historic past and the demographic future suggest that UK property shows all the signs of continuing to outperform equities in the long term - as it has done over the past 20 years. There will always remain a demand for property funds, but even their champions would not seriously compare their historic performance with direct property investment. And some of their apparent benefits, such as liquidity, are less clear on closer inspection.