The feedback from my two articles on alternative investments was surprisingly enthusiastic. This tells me that investors are actively looking for higher-yielding investment options during the current low fixed-income environment.
I would like to introduce another choice that affords investors secure and steady returns above current market rates. This is not a new concept, but such an old, staid investment that it has almost been overlooked.
Have you ever heard of ground rents? This is a unique feature of the UK property market. Available to expats, these are a form of investment that produce secure returns at rates priced attractively higher than more common fixed rate holdings such as bank deposits or bonds.
They relate to leasehold buildings in the UK. Most expats are familiar with leasehold property. When you "purchase" a property as a lease, what you actually purchase is the right to use the property for a fixed term. These terms vary by property. In the UK they are commonly anything from 99 to 999 years.
By purchasing the lease you are not buying any land or even the actual building; just the right to use it. Someone must own the land on which the property stands and the building in which the units are held. This person or party is called the freeholder. When you own the freehold and lease individual units of the development to various "owners", they pay an annual ground rent to the freeholder.
Most people who are aware of these ground rents dismiss them as insignificant. In fact, ground rent provides a steady fixed income that is guaranteed. Because you own the property, if a leaseholder does not pay you the ground rent, you can repossess the unit it relates to and sell the lease to another leasehold "buyer".
What about the costs involved in running the building you own? Individual leaseholders are collectively responsible for these costs. This is written into the lease agreements and thus the liability for maintenance costs is locked in for all concerned.
The freeholder must ensure that outgoing expenses, such as insurance and maintenance costs, are paid, but these costs are actually met by the leaseholders. Therefore the ground rent is encumbrance-free income.
The freeholder is responsible for ensuring that tasks are carried out and the building exterior is correctly maintained. This can be undertaken by a management company on your behalf. Their service fee will be fixed and all associated direct costs are covered by the leaseholders. Thus you are aware of exactly what your income will be.
If property prices generally drop in the UK, freehold values will be unaffected. This is because individual leasehold units directly relate to the emotional market forces of the current housing situation. However, freehold values relate to a multiple of the annual ground rent, which cannot be reduced. Therefore your income is guaranteed and the capital value will not reduce.
Correlation between freehold and leasehold unit values is astoundingly absent. Each individual building is unique but taking a typical example you may get these figures:
A building consists of, say, 10 apartment units.
Each unit will sell, on leasehold, for an average of some 250,000 (12.2 million baht).
Thus the total leasehold value would be 2.5 million.
The average ground rent is 1,800 per unit per year, making a total of 18,000.
The freehold is typically considered to be somewhere around 17 times the ground rent value.
Thus the freehold value is 306,000.
As discussed, capital outlays are much smaller in proportion to the value of the individual leasehold units in a development. Again this is because they relate to a multiple of the ground rental value rather than the market forces of dwelling units.
Once purchased the income is guaranteed. With an investment from as low as 10,000, you can own such a freehold. Returns are rarely less than 6% per year, after all costs.
At the conclusion of the lease period, new leases will be offered to current leaseholders at a fee, which will be yours to keep. Ground rents traditionally double each time a lease period is renewed.
Therefore the freehold value of each development increases as time moves forward because the ground rents are increased and a renewal fee is charged.
Many readers will view this as too good to be true. To be honest, I was also rather sceptical and have been studying the concept and actual operations for some time now. Here are the main features and advantages:
Non-correlated asset: The capital value and income are unaffected by influence of any other markets, such as equity, bond and commodity markets.
Secure asset: The land ownership is registered with the British government. There are no restrictions to foreign owners in the UK. Your asset is thus registered with you as the owner.
Succession planning tool: This asset is permanently owned by you and may be passed on to your heirs as part of a succession plan.
Returns will be a minimum of 6% per year after all costs.
Capital value does not reduce over time as the freehold value relates to a multiple of the annual ground rent value.
An exit strategy of 60 days allows a relatively quick return of capital in the property asset class.
What about this exit strategy? We all know that property is a long-term investment and markets can be fickle depending on the current economic climate. Because freeholds are purchased and sold by investors rather than as individual properties, they tend to be dealt in a more arms-length fashion. Thus the resale market is easier than the open housing property market. You will also find that a good management company will be able to assist you in making an exit if required.
There is no catch to this asset. It is a simple concept that has almost been forgotten and not capitalised on for a long time. Ground rents have been in existence for more than 200 years. During times of high interest rates the annual returns of 6% are considered inadequate.
There are some ground rent funds around. These are good investments that return at a steady pace. However, direct ownership is not complex and enables the investor to enjoy net returns without the risk of any associated liabilities.
If you have an offshore personal portfolio bond (OPPB) or similar type of investment vehicle, particularly those with open architecture, some of the alternative options are available to you via your OPPB. However, if you feel that a direct investment is best for you, then these options will provide really great ideas for you to have your own private holdings.
Here is a very good reason to contact a professional financial adviser to find out more about this opportunity.
Andrew Wood has been an expat in Asia for 33 years and is executive director of PFS International. His articles, which cover the complete A-Z of financial planning, are available through the PFS library to readers on request. Questions to the author can be directed to PFS International on 02-653-1971 or emailed to firstname.lastname@example.org.
About the author
- Writer: Andrew Wood