Invest from an armchair

Property is one solution for someone with a nest egg who is averse to risk

NAME: Sandra Allchurch

AGE: 46

OCCUPATION: Local government manager

THE ISSUE: Sandra recently divorced and, as part of her settlement, she received a lump sum of pounds 100,000. She is cautious, cannot take risks and her money has been tied up in a building society for some time.

A friend has suggested buying a flat or a small house with slightly over half the money and renting it out. Sandra would like to know the pros and cons of such a move.

THE ADVISER: Andrew Reeves FCA, proprietor of Andrew Reeves & Co, a property letting and managing agency, 4 High Street, Bromley, Kent BR1 1EA (0181- 464 8566). Also a national council member of the Association of Residential Letting Agents (01923 896555).

THE ADVICE: "My first advice is that Sandra should not put all her eggs in one basket. Her idea that some pounds 60,000 should be invested in residential property for letting purposes is a sound one.

Having made a decision to invest in property, she should firstly decide whether she wishes to simply use her own capital or raise additional funds through a mortgage.

With her own capital, she could buy one or perhaps two properties, and expect to receive a rental return of about 10 or 12 per cent on capital employed. After running expenses such as insurance, agents, fees, repairs and maintenance, her net return is likely to be 7 to 8 per cent per annum, before tax. It is important she takes expert advice locally before buying a property, to ensure she makes the right choice.

It may not be her idea of a "dream cottage", but should be chosen instead for its appeal to tenants. It should be convenient to shops, schools and transport links, in good condition, preferably with modern kitchen and bathroom - and economical to maintain.

Whether the property should be furnished or provided with the basics - carpets, curtains and some kitchen appliances - should be decided after conferring with the letting agent. While furnished is the norm, some areas are experiencing greater demand for unfurnished properties.

To fully equip and furnish a two-bedroomed property might cost around pounds 3,000 but the benefits can be higher rent levels, longer occupancy per tenant, and therefore less risk of void periods with each change of tenants.

Being in full-time employment, Sandra is unlikely to want to adopt a "hands-on" approach. Agents not only find tenants, but also collect the rent and manage the property. This typically costs 12.5-15 per cent of the rent.

Sandra has the option of raising further funds by way of investment mortgages available under the ARLA Buy-to-Let scheme, and of purchasing, say, four or five properties rather than two. The main attraction here is capital appreciation. By dividing her own funds into smaller amounts of pounds 12,000 or pounds 15,000 and raising twice as much again, she will increase the gain threefold. A 5 per cent growth in property values would amount to a 15 per cent capital gain for investors "geared up" in this way.

Buy-to-Let mortgage lenders, including household names such as Halifax, Woolwich and NatWest, as well as specialist lenders Mortgage Trust, Mortgage Express and Paragon, will lend up to 75 per cent or even 80 per cent of a property's value.

It would, however, be prudent to borrow no more than 65 per cent to keep interest payments down and provide a buffer against future rises in rates. Interest currently charged is typically 0.5 per cent above standard variable home-loan rates. All lenders also offer a fixed rate for anything from three to 10 years. The usual multiple-of-income calculations will be made, but rental income from the property being bought is taken into account. The costs of the ARLA Buy-to-Let scheme are typically pounds 300 to pounds 400, which includes valuation and arrangement fees. Legal fees to buy the property should be no more than 0.5 per cent of the purchase price.

The main difference in the financial position if mortgage funds are raised is that most of the net rental income goes to meet monthly interest payments. If Sandra is looking for a regular monthly income from her investment, then this would not be the route to take.

However, it is very tax-efficient to borrow to buy a property to let, as all interest payments are fully allowable against income tax. Set up correctly, it is possible to minimise or avoid altogether income tax payments on rental income by balancing allowable outgoings against income. All running expenses of the property are generally allowable, with only capital expenses being excluded. However, a wear-and-tear tax allowance of about 10 per cent of the annual rent is available for furnished rented property.

Capital gains tax is payable at the marginal rate of income tax when the property is eventually sold, although this should be less than expected, since gains are adjusted for inflation by reference to the RPI over the period of the investment. For instance, if a property increases by 10 per cent over a period in which inflation was 5 per cent, capital gains are only paid on the 5 per cent difference in value.

Clearly, property investors must accept that they may be subject to CGT, unlike some other investments. Equally, property investment is often made because a "bricks-and-mortar" investment is more appropriate to certain people's risk profiles.

She should bear in mind that, just as with other investments, the value of properties can go down as well as up. The appeal of property investment to Sandra might be that she will own an asset situated in her local area which she can "walk past". It will provide an income every year for as long as it is held, or if purchased on a mortgage, will pay for itself over, say, 15 or 20 years, after which the additional income will supplement a pension throughout her retirement years. Managed correctly, property ownership is very much an "armchair" investment.