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An introduction to property investing: direct vs indirect investing
Property is one of the most varied asset classes available. Giving you the ability to invest in numerous different ways, across a number of different investment structures and into opportunities that can tick the boxes of most investor requirements, understanding the details is necessary to ensuring you get the most from your investments.
As a property investor, new or experienced, there's a need to make certain decisions to ensure you're investing in the right property opportunities for you. Some are really intricate points whilst others are more high level, and today I want to look at one of the latter - the difference between direct and indirect property investing.
What is direct property investing?
Direct property investing is the name given to the purchase, ownership, rental, management and/or sale of property for profit and returns. This can involve the purchase of a property to make money from rental in the short term and profit on sale in the long term, or it can involve buying a property for less than market value, making improvements and selling for a profit soon after.
Yet however the profit is achieved, direct investing is capital rich and cash flow dependent. In some cases it also relies on bank lending and mortgages being obtained, ideally at beneficially low interest rates, so to ensure the interest paid on the lending doesn’t eat too much into the profit from the development or rental yield.
The direct investing trend in the 90s and early 00s was buy-to-let property, which was beneficial to the investors / landlords, not only because of the rent they received from the tenants, but the relief that could be claimed and deferred against tax for both the mortgage interest payments and also ‘wear and tear’ allowances on the properties.
Since the change in legislation, the primary tax relief available to investors is to be capped at 20%, a considerable decrease for many investors, particularly those in the higher income tax brackets. This has led to a lot of property investors selling less yielding properties, or indeed selling their full portfolio with a view to investing their capital into more beneficial - or lucrative - property opportunities.
Moreover, the increase in stamp duty and new rules around second homes has made the buy-to-let proposition even more unattractive to investors.
But with that said, direct investing opportunities are still available. And they're plentiful. Plus, we can't ignore the fact direct property investing is immensely popular as a concept. It's the route that the majority of people will think of first and as such, it's the one that many can feel most comfortable with - and for someone new to property investing, this can be a very positive element.
What is indirect property investing?
Conversely, indirect property investing is the motion of investing into property through a bond, peer-to-peer (P2P) lending platform or crowdfunding scheme, investing into a deal alongside other professional investors and potentially institutions.
When investing in such a scheme or opportunity, you will be provided with a repayment schedule that sets out how your capital will be repaid and how any potential interest on your capital will be paid.
Some schedules will outline a development period and target return (for example, Chilton has an 18-22 month rolling development period with a target return of 1.5x) and some will be more regular, such as a bond paying a certain percentage coupon per annum and returning the original investment, in addition to a targeted financial profit after a set number of years by following a bond-style structure.
Asset backed, indirect property investing is often seen as having less risk than direct property investing - and particularly less than early-stage company investments. However, it's important to understand there is still a level of risk involved. As with any investment opportunity, there is no guarantee that your capital will be returned or a profit realised.
But the rewards that can be sought from such an investment type generally help to outweigh the risks to an investor and by taking the necessary steps to understanding the opportunities in-depth, you can be confident you're investing in the right opportunities for your risk preference.
Understanding the differences and making the right choice for you
With the differences between direct and indirect property investment opportunities on a high level laid out, let's look at some of the specific points you need to consider to help you make a decision:
- Direct investing has more of a need for capital at the outset than indirect investing - to consider direct investment opportunities, you need to have the capital available to complete the full purchase (or part purchase, part borrowing) of the property before financial gains can start to be achieved. Indirect investing, generally speaking, has a much lower financial entry point.
- Reliefs are available for direct property investors on the capital invested - for those investors who have invested directly into property, tax reliefs are available, as is the ability to defer taxes for some. This simply isn't available to indirect investors. These tax reliefs are decreasing, however, which can make the opportunities less appealing than they once were.
- There are varying timescales for returns - both direct and indirect options have different opportunities for investors seeking gains in the short or long term. For example, an investment into an indirect property development project could realise a return in 18 months, but the direct purchase of a commercial property that's let out could require five years of constant rent being received before profit is generated. However, you could make an indirect investment into a property fund and not see returns for several years if the market turns, but conversely you could directly buy, renovate and sell a residential property in a matter of months.
- There can be a clear split between passive and active opportunities - although you can, in theory, be an active or passive investor in both direct and indirect investments, generally speaking direct investing is more active-based as it involves the management and/or renovation of a site or project by the investor and their contractors. Similarly, indirect property investing is generally seen as a passive option; a capital-only investment with the developer and management team updating the investor of the progress, returns and any potential issues that may arise.
- They both have low risk levels available - direct and indirect property investments have some of the lowest levels of risk, particularly in comparison to early stage companies and EIS eligible investments, although the levels of risk differ between individual schemes, properties and opportunities.
- It can be easier to diversify with indirect investments - this is dependent on the level of capital available to invest, but with indirect property investing an investor could put capital into several schemes or opportunities at the same time. With direct property investing, it tends to be one or two properties that are invested into (where funds will allow), meaning their portfolio tends to be smaller but using the same quantity of funds.
Making an informed investment choice
A successful investment portfolio is built on knowledge, experience and receiving advice from professionals. Understanding the difference between direct and indirect property investments is a necessity, but it's only one of the questions you need to be able to answer confidently.
We've talked about the various options within property investing a lot, and our guide to 'integrating property into your investment portfolio' goes more in-depth to help you make the most informed decision possible when determining which property investment opportunities are right for you.