Swapping a rental property for a share portfolio

Having sold my London rental flat, what was I to do next?

I’ve paid the £20k+ transaction fees. I have paid off the mortgage. I set aside the amount to pay my Capital Gains Tax, a liability which needs to be settled within 60 days. I moved some of the remaining equity into other investments and portfolios.

However, one thing is missing. The property rental income. I used to use my property rental income to help pay for household costs; rent was received into my joint household account and was swallowed up there by miscellaneous household bills, cleaning costs, gardening expenses etc. Until I sold the flat, the flat’s service charge and occasional running costs would have come out of that account too. These days, only my Dream Home in London is paid for out of this account – I have opened a different account for the Coastal Folly which I run separately (and is funded separately).

So, I decided to ringfence £500k of the equity that I released for a ‘property proxy’ portfolio. This portfolio will be a worked example of the argument that a stocks/bonds portfolio can be a valid, and better, alternative to a property investment. I will report on progress occasionally on this blog. The portfolio will essentially be an income portfolio, designed for somebody is used to having regular property rental income coming in, and wanting inflation protection.

I kicked off the portfolio around 1 November 2024, using one of the mainstream platforms – something any reader could do using Interactive Investor, AJ Bell, Hargreaves Lansdown or similar.

‘Property proxy’ portfolio objectives

As a stock portfolio this portfolio should have a couple of advantages over a property investment:

• Easier to value
• More liquid – I can release funds at a moment notice
• Lower fees – certainly comparable to fees of ~10% of income that come with a letting agent etc

To be broadly comparable with a residential London rental flat, my investment objectives for this portfolio are as follows:

• Regular income – monthly or quarterly
• Growing with UK inflation – or better – over time

£500k of stocks vs £1m flat

Now, readers with above average attention span and memory recall will notice that the flat I just sold was worth about £1m, and might be wondering whether a £500k equity portfolio is a fair substitute.

Those readers have a point. But the two investment amounts are more comparable than it first appears.

My flat was “almost £1m”, and it was leveraged. So the net equity value of my investment was closer to £800k than £900k.

But the real comparison I want to make is to income, not value.

My flat produced around £4k per month of rental income. But after agency fees, the service charge and mortgage costs I was left with not much more than £2k per month of cashflow. And no appreciable capital gain.

To obtain a monthly of income of £2k pcm requires a £600k portfolio, using the rule of thumb that 4.0% is a Safe Withdrawal Rate. But I am going to try to live a little, and run a yield-centric portfolio with a slightly higher income rate than 4% and see how I get on.

Designing my ‘property proxy’ portfolio

I’m creating my portfolio as follows:

• No more than 10 holdings, i.e. an average holding size of about £50k. All holdings to be listed equities/similar – not Funds.
• I’m going to bias towards UK property – which I can do via listed equities. This means I can look for an attractive income yield, and of course UK properties in theory are relatively inflation-proof -hopefully helping me hit the inflation-tracking objective I have for the portfolio.
• I’m going to include a portion of global growth, as a hedge against a UK income/property portfolio remaining in the doldrums.
• I’m sizing rather idiosyncratically, using my personal judgement about risk, expected dividend/income levels, and level of confidence in the next X months. But to some extent I’m using about £400k of the portfolio to buy the income I need, and the balancing item to buy a global growth tracker.
• I’m not using any leverage. The underlying holdings might – e.g. the property companies – but my portfolio won’t.
• I will keep a cash buffer. How much? The professionals would say to keep a year’s income – about £25k at hand. I am going to run a bit skinnier than that. I’m going to keep only one quarter’s income left as cash – which means £6k in cash

Running my portfolio

Here’s how I intend to run the portfolio:

• Monthly withdrawal set up at £2k pcm. I plan to increase this every November by inflation – CPI.
• Any surplus cash above the cash buffer, I will reinvest. I’m not quite how I’ll do this yet, but probably into a mixture of whatever spat out the dividend, whatever appears to be good value, and my global growth tracker.
• Very few Sells. Hopefully less than one per year. Though if a growth stock has some gains, I may realise them.
• I’m ignoring tax. Yes, I will pay it, but not out of this portfolio. Which means this portfolio is equivalent to an ISA portfolio that (unlike mine!) has £2k pcm withdrawn every month.

My initial portfolio

Here’s my initial set of holdings, as made around October/November 2024.

• AEWU. A property REIT, focusing on commercial property mostly outside London. Yielding about 8%.
• CTY. Essentially a FTSE-100 tracker, but with a small layer of active management that commits to dividends increasing with inflation.
• Land Securities. Another property REIT, also with a focus on premium commercial property – a lot of which is in London. Yielding about 6%.
• LGEN. One of the UK’s biggest insurance companies. Share price has been resolutely stuck in the 200p-250p range forever and a day, but the dividend yield of 9% is about as safe as a high dividend yield can be.
• NTEA. A high yield bond, from Northern Electric, yielding about 6%.
• NWBD. A high yield bond-equivalent, from Natwest, yielding about 6%.
• RGL. Another property REIT, focused on regional commercial property across the UK. This has been a troubled holding, but post a share split the dividend feels reasonably safe and the yield is almost 7%.
• VGOV. UK government bonds. They yield about 4% at the moment.
• VWRL. World equity tracker. This is my ‘residual item’ – to ensure I have some exposure to world equities, which after all generally deliver 5% real (i.e. above inflation) returns a year. However the yield is low – only 1.5%.

My initial allocation is shown in the table below. I’ve gone with 80% (£400k) equities, 20% bonds. LGEN is the anchor of the equity portfolio, with £100k/20% weight, and expected to generate over a third of the desired income. I’ve then got three £50k equity/REIT holdings, three £33k bond holdings and a rump £27k RGL holding on the naughty step. This lot should deliver at least £24k of income. A £117k VWRL holding tops the income up by £1800 and hopefully will help secure some capital appreciation.

Talking of capital appreciation, I am expecting that to be the rub with this portfolio. My bond holdings are not going to adequately protect against inflation. The REITS should see inflation-linked gains but I am not expecting much more than that. So for my portfolio to deliver both a ~5% yield and track inflation (~3% per year) I need some capital appreciation from somewhere. I do expect a slight surplus of income after the £2k pcm have been withdrawn of, perhaps £4k/0.8% of the portfolio and this will be re-invested. I am then hoping VWRL will deliver reasonable capital appreciation – of potentially £8k/1.6% a year (on a long term average), roughly enough to compensate for the £100k of bond holdings that I expect to lag inflation.

What can possibly go wrong?

So, I’m definitely facing Sequence of Returns Risk, not to mention some single stock risk (here’s looking at you, RGL). But in theory this portfolio should be able to deliver £2k pcm for a good while yet.

As an alternative, there’s always Mountview Estates – as covered by Monevator‘s The Investor ££here.

I’ll keep you all posted.