Right now seems like a great time for UK investors looking for passive income. Mortgage rates are above last year’s mini-budget levels, creating what I think are great opportunities.
The average rate on a two-year fixed mortgage is now above 6% – the highest it’s been for 15 years. So how can investors looking for a second income use this to their advantage?
Property market
Higher mortgage rates create a headwind for property prices. It reduces demand from both buyers looking for somewhere to live and investors looking to generate rental income.
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More expensive mortgages reduce the amount potential homebuyers can borrow. As a result, the amount they’re willing to pay for houses goes down.
For investors, higher interest rates mean the return they need to generate from the property to justify the purchase goes up. That means they need to buy properties at lower prices.
With mortgage rates at their highest level in more than a decade, this looks to me like a great time to invest in the property market. But what’s the best way for someone like me to do this?
Buy-to-let
One way of earning income through property is by buying a property to rent out. With demand in the market falling, there might be a decent chance to find a bargain.
There are two major downsides to this approach, though. It takes a lot of cash and it involves a lot of work.
Unless I have enough cash to buy a property outright (which I don’t) I’ll need to fund the purchase with a mortgage. And those are at their most expensive levels for 10 years.
Additionally, finding a tenant and maintaining a property can be a lot of work. I could outsource it to an agency, but that would cut into my rental income.
I can see there’s a good opportunity in the property market for an investor with a lot of cash and a lot of time at the moment. But I think there’s a better alternative for someone like me.
REITs
Instead of buying a property to let, I’m looking at investing in real estate investment trusts (REITs). These are companies that own and lease properties to tenants.
REITs are exempt from taxes on their corporate earnings. In exchange, they distribute 90% of their rental income to their shareholders as dividends.
This gets me around both of the problems with buy-to-let properties. I can invest in a REIT with as little as £1 and I don’t have to manage a property – the income is genuinely passive.
A number of UK REITs have seen their share prices decline lately, as the market value of their properties has been falling. Therein lies the opportunity, from my perspective.
Right now, there are some attractive-looking dividends on offer. Primary Health Properties (6.75%), LondonMetric Property (5.47%), and Warehouse REIT (7.5%) are top of my list at the moment.
Opportunities
The risk with REITs is rising interest rates might cause tenants to default on their rent obligations. That would be a problem from an income perspective.
As far as I can see, though, there’s not much sign of that yet. And the falling share prices mean I think there’s a rare opportunity in the property market for UK passive income investors.
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