Investments Topic 6 - Property and Structured Products Flashcards
Things to consider if you are going to buy a buy-to-let:
- Location of the property
- The type of property
- Management of the property
- The type of tenancy
- Finance
- The impact of changes to the taxation treatment of buy-to-let property
Disadvantages of residential property as an investmen
- Tenants are not guaranteed
- The house will have to be repaired on a regular basis to keep up to standard
- Quality of tenants not guaranteed
- House price are not guaranteed to rise
- Property is not liquid
Calculation for property yield
Gross rent less annual expenses/property costs plus acquisition costs
Capital growth is good in property as:
- House prices are rising well ahead of wage rises
- Limited supply driving prices up
- Lack of ‘affordable’ home
- The bubble spreads – London commuters will start to buy house in the feeder areas surrounding, driving those house prices up as well as London houses
Commercial property split into 3 categories
retail, offices and industrial
Disadvantages of commercial property:
- Vulnerability to economic conditions
- Lack of tenants
- High costs
- The need for ongoing management
- Availability
- Ease of sale
Things affecting residential property valuation
- Subject to S&D
- Must be valuable enough for lenders to cover the mortgage
- Location
- Design
- Age and condition
Things affecting Buy-to-let property valuation
- Also subject to S&D
- Amount and availability in the same area
- Potential rental yield
- Local rental market
Things affecting commercial property valuation
- S&D
- The type of use of the property
- Assets to be included (factory equipment for example)
- Position – if its on a high street worth more than a side street
- Restrictions on usage
If an individual is renting a furnished room in their house, they can earn up to… income tax-free from the rent per year
£7,500
If an individual is renting a furnished room in their house they can choose to be taxed in 1 of 2 ways:
- On total rent received less expenses
- On the excess over the threshold with no deduction for expenses
Residential property used as the owner’s home is exempt from CGT, as long as it follows these rules:
- Must be the main residence
- Land of up to 0.5 hectares (roughly 1 acre)
- The owner can delay occupying the property for up to 12 months (can be extended another 12 months if proven necessary)
- As long as the property has been the owner’s main residence, the last 9 months are exempt from CGT
- Exemption may be affected if part of the property is used for commercial use
- Those who live in job-related accommodation can elect a different property as their primary
Income tax features of residential and commerical property
- Rent money taxed as income
- Income received gross, so tax is assessed through self-assessment
- Income below a threshold does not need to compete self-assessment
- Certain expenses can be claimed against the rent, such as repairs, maintenance, loan interest payments etc.
- Losses made can be carried forward to future lettings profits
Since 2017, mortgage interest tax-relief is restricted to
20%
SDLT
Buy-to-let and second homes:
- Since 2016, buyers of non-private properties must pay an additional SDLT tax charge
- Threshold is property valued over £40,000
- This is on top of the ‘normal’ SDLT charge
SDLT in Scotland
- Scotland have powers to alter their tax rules
- Since 2015, SDLT has been replaced by Land and Building Transaction Tax
- Works the same as SDLT, but different bands are in place
- Additional dwelling supplement (ADS) is in place for non-private properties over £40,000
SDLT in Wales
- Welsh government changed SDLT to Land Transaction Tax (LTT) in 2018
- Similar surcharge applies to non-private properties
- Different bands yet again
What are Special Purpose Vehicles (SPVs)
- Limited company set up to purchase buy-to-let properties
- Includes a board of directors and shareholders
- Instead of individuals owning the property, the company owns the property
- This means shareholders will receive income through shares rather than rent
- They can deduct mortgage costs off this way
- Dividend allowance and tax rate means you can pay much less tax
Investing in property indirectly through collective investment schemes
Unit trusts and OEICs:
- pooled investment, each share/unit is linked to value of the property
- Deferred period for withdrawals because managers have to sell the property
- Period typically 3-6 months
What are listed property companies and investment trusts
- Many of these are listed on the stock exchange
- The investor buys shares into the company and can withdraw at any time by selling shares
- The share price is affected by the way the property is managed, the company’s borrowing, rental yield and the value of the property.
How are Real estate investment trusts (REIT) taxed
- the property is split into 2 parts – property rental business and general property business. The rental business is ring-fenced so it can be clearly separated for income purposes
- Subject to other criteria, the company will be exempt from CT providing it distributes 90% of its profits
- This distribution is called property income distribution (PID) and is paid net of income tax. Distribution of investments held in tax wrappers (e.g. ISAs) are paid gross
- Other profits made from the business from the non-lettings side of things is subject to CT as normal
What is the aim of Property authorised investment funds (PAIFs)
The aim is to provide an instrument that allows the investor to be taxed in the same way as if they owned the property directly, rather than through a third party.
At least 60% of the income must derive from property investment business (real property, shares in UK REITs) and at least 60% of the PAIF assets must be property holdings.
What are the tax implications for a PAIF
For taxation, the PAIF is split into 3 categories:
- Property income distributions – exempt from CT but income on distributions are paid.
- Dividend distributions
- Interest distributions
4 main differences between PAIFs and REITs
- PAIFs are open-ended
- REIT is required to pay out 90% of income received, whereas PAIF is required to distribute 100% received
- PAIF can offer distribution shares, which pay the income the PAIF receives, or accumulation shares which reinvests the income. REITs only issue ordinary shares
- PAID share prices represent underlying asset value, REIT shares are priced by the market
Key features of guaranteed equity bond
- Defined lifespan – 3 to 5 years
- Investors original capital returned at maturity
- Investor receives percentage or growth in the FTSE 100 (or other) index
- Some other products offer a fixed rate of growth providing the index is higher at the end of the term
Guaranteed equity bond can be complex to arrange and is split into 2 types of investment:
- Capital return is provided by a zero-coupon bond. The bond is heavily discounted from the par value but there is no interest paid. The par value of the bond is equal to the capital invested, so at maturity date the bond is worth the capital invested
- The growth element is based on gambling on the index through call options, hence why the growth is not certain
What are Capital-at-risk (CAR) products
defined by the FCA to describe products that offer higher rates of return for an element of risk, this uses stock market investments – shares, debt securities and derivatives.
Capital-at-risk products are similar to guaranteed prodcuts, but the main difference is
underlying investments are different, as ZCBs are replaced with derivatives creating more risk
When talking about Capital-at-risk (CAR) products, what is meant as the ‘barrier’
These products offer ‘soft protection’, which means that capital can be unsafe if the index falls below the stated level, known as the ‘barrier’ – usually 50% of the index’s starting point.
There are 2 types of product within CAR products
income and growth
Income products for CAR products will use …
medium-term notes (MTNs) rather than ZCBs
How to MTNs work
MTNs are a form of bond issued by companies directly to institutions and high-net-worth individuals, and are not ‘one-off’ bonds, they can be on a continuous basis.
Kick-out (or ‘autocall’) plans
This product offers a fixed rate of growth after a five-year term, but has an early termination clause which states that if the index is above the starting level on the anniversary, you can withdraw.
Investor considerations for structured products
- The underlying asset class of the product
- The level of capital protection offered
- The counterparty risk (company offering the ZCB or MTN)
- Liquidity and access
- The calculation used to determine the final index value
- ‘Accelerated growth’ plans – these offer much bigger growth but for much less capital protection
- Protection for investors – making sure companies are covered by compensation schemes etc.
