Satwaki Chanda outlines some of the advantages and disadvantages of investing in property through a real estate investment trust.
A real estate investment trust (REIT) is a special type of company in the UK that invests in real estate – buying property and letting it out to tenants. The type of property can be commercial or residential – as well as investing directly in bricks and mortar, they can also invest through partnerships and joint ventures, and even in other REITs.
REITs come in all shapes and sizes. There are the well-known ‘blue chip’ companies like British Land, who are generalists, or more specialised companies such as Primary Healthcare Properties who invest in doctor’s surgeries – very attractive since the rents are government backed. You can invest in a REIT by buying its shares through a stock market, the London Stock Exchange. Although they were first introduced with a view to getting retail investors interested, they are for everyone – institutional investors, both UK and overseas.
What are the benefits of investing in a REIT?
There are two benefits, both of which are inextricably linked:
- first of all, a REIT can be thought of as a fund, pooling its shareholder’s capital and investing it on their behalf. Not everyone has the skill or ability to invest in property – it takes a lot of time and effort doing it on your own. But doing it through a fund means you have access to professional expertise, whose job it is to generate returns for their investors. And you have a ready-made diversified property portfolio simply by buying shares in a single company rather than buying them yourself. The fact that the shares are listed on the stock market also makes it easier to access the property market – shares are more liquid than real estate, though how liquid they are will depend on the stock in question; and
- the second benefit is the tax advantages. REIT’s pay no tax on their rental profits and no tax on their capital gains. The capital gains exemption is something they share with a lot of other UK fund vehicles, but the exemption on income is what gives it an edge. The idea is to shift the tax burden from the fund level to the investor – each investor can be thought of as running his own little private property venture and so he’s placed on the same footing as if he was investing directly. This is achieved by the fact that REITs have to pay out at least 90% of their rental profits to shareholders – they are effectively a conduit for passing on the rent. However, unlike partnerships, capital gains aren’t imputed to investors each time a property is sold – gains are only taxed if and when investors sell their shares.
What are the disadvantages of investing in a REIT?
The tax breaks come with a catch. There are various conditions that a company needs to satisfy – some of them may be so onerous that it’s just not worth it. For example, at least 75% of the business income and assets must come from renting out property – but not all property related activities, such as property development, count as property letting – not only are they outside the exemption but having too much property development could jeopardise the REIT’s status. It’s for this reason that some UK companies such as Helical Bar decided not to become REITs in the first place.
Another factor to bear in mind is that there are stringent rules on the amount of debt cover, though these have been lightened recently. Bearing in mind that property investment is a highly-geared form of activity, these rules may hamper a company’s borrowing options.
The following diagram illustrates how a REIT is taxed both at fund and investor level.
Practical Tip:
Investing in a REIT can sound exciting at first, as the tax advantages do look attractive. However, the tax breaks on their own will not deliver superior investment returns. Investors should always remember to look at the company’s performance first and foremost before deciding whether to part with their hard-earned cash.
