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Residential Property: Short term bonds as an indirect alternative to buy to let

Bricks and mortar are ever popular with those looking for a solid, asset-backed investment. This is no surprise as residential property can offer an important diversification opportunity within a mainstream portfolio and as an asset class, it shows low correlation with UK equities, fixed interest and cash over the medium to long term. (Professional Adviser).

Of course, those landlords using buy-to-lets to get other people to pay off their mortgages have benefitted significantly from low interest rates over the last decade. But those with more funds to invest are likely to be concerned with the prospect of rate rises; in early July, Professional Adviser stated, “with inflation remaining above target yet economic performance mixed, [..] commentators are now divided on whether there will be a rate rise later in the year – and perhaps even as early as August.

Yet, while some areas – most notably those in and around London – have seen house price falls, others have seen continuing house price growth. UK city house price inflation was +4.6% over the last 12 months. (Hometrack UK Cities House Price Index, May 2018).

Another strong metric is rental income. The Office for National Statistics reported in May this year that, “Between January 2011 and May 2018, private rental prices in Great Britain increased by 15.8%; this was strongly driven by growth in private rental prices within London. When London is excluded from these figures, private rental prices increased by 12.4% over the same period.” This looks attractive, although when annualised only equates to just over 2% p.a. outside London.

No matter what the growth and income aspects are, a landlord does have total control of their investment. But, this is a double-edged sword as all the control comes with all the responsibility.  That means responsibility for costs, including maintenance, insurance and tax. Added to which, the administration can be time-consuming and bring the need for professional services such as lettings agents or, in the event of issues with tenants, solicitors.  Neither of these comes cheap.

Then there is current government sentiment which seems to be fairly negative in relation to residential buy-to-let portfolios. Under new rules being phased in over the next few years, landlords will progressively lose valuable tax relief on their buy-to-let mortgage costs.  The government has also pledged to introduce new rules making it illegal to charge tenants for things like references or inventories. With the expectation that these costs will need to be absorbed by landlords, the margins of buy-to-lets are certainly being squeezed.

Nevertheless, this sector can boast attractive returns and low volatility over the longer term, regardless of the economic cycle. But what if you’re looking for something shorter term? Something  with a pleasing return, the possibility of re-investment in future tranches, and none of the administration and cost headaches of taking a direct stake in residential housing?

One alternative to direct investment is the indirect route of short term bonds.

Oxford Capital, for example, has recently launched a Residential Development Bond which leverages the demand for housing by making loans to UK house builders. Returns are generated by charging interest and fees on these loans and not by investing in, or taking ownership of property. But the bricks and mortar do ultimately form part of the security taken on behalf of the bondholders.

The 12-month bond offers a 7% fixed coupon and £10,000 entry level without any of the costs or administration burdens of actually owning the residential properties. It funds the smaller but experienced developers that have struggled for finance in the last decade and which have been identified as a crucial factor in resolving the UK housing crisis.

Other advantages of this sector include the ability to diversify across various smaller projects in different areas to offset the lumpy performance of the UK housing market; house price growth across the twenty cities in the Hometrack UK Cities House Price Index ranged from 7.1% to -5.7% in May 2018.

Furthermore, with smaller developers, come smaller housing developments. This gives an element of exclusivity, particularly with the build quality of the types of companies targeted by Oxford Capital which has already been involved in lending around £50 million. And, with substantially fewer houses to sell than is typically the case on large housing developments, the premise is that the sale of a sufficient number to pay off the developers’ debts, will be relatively speedy. Since bondholders are positioned as first in line to receive their capital and coupon on the sale of completed houses, this is certainly an interesting proposition.

Learn more about Oxford Capital’s Residential Development Bond.

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