Real Estate Investment Trusts REITS

---

 

Real Estate Investment Trusts REITS pronounced "reets" are tax efficient funds structured as investment trusts that invest in real estate or property. As quoted companies REITs do not pay Capital Gains Tax or tax on rental income received from the properties held in the fund.

 

• When were REITS launchedWhat do REITs doWhat are the advantages of REITsWhat is the outlook for property investmentWhat are the disadvantages to REITsWhich is the right REIT for meAre REITs popular investment choicesWant to track your investments Moneyextra.coms free portfolio service has all the tools you need.Top of PageAre you looking for a share dealing account Do you want to manage your portfolio online but dont want to trade more than twice a month Try Moneyextra.com Trader!Top of PageTop of PageWant to set up an online share trading account Will you be an active trader Check out Moneyextra.coms frequent trader service.Top of PageTop of PageDo you need unbiased independent financial advice Why not give us a callTop of PageTop of PageMoneyextra.com

When were REITS launched

Real Estate Investment Trusts REITs became available in the UK from 1 January 2007 but were operating globally in 20 countries before then. The tax-specific origins of REITS can be traced back to the USA as far back as the 1880s. It was also here that they really started to take off 100 years later in the 1980s. Currently REITS are most popular in Japan Australia and the Netherlands.

 

What do REITs do

As it says on the tin REITs are funds that invest in real estate the collective American term for commercial residential and retail property. They use investors assets to buy properties which in turn are then let out to companies and individuals.

 

REITs are structured as investment trusts and therefore amount to a quoted company. This means they can issue shares which will be traded on the stock market.

 

Since January 2007 various property companies have chosen to convert into REITs including British Land Land Securities and Slough Estates. In order to do this the property company must meet certain criteria. For example they must be listed on the London Stock Exchange main market or a Government recognised overseas exchange.

 

Converting companies which must be domiciled in the UK were required to pay a conversion charge equal to 2 of their net asset value NAV. In addition they had to agree that no single party may hold more than 10 of the share capital.

 

What are the advantages of REITs

The main advantages of REITs are unsurprisingly tax-related. As quoted companies REITs do not pay Capital Gains Tax or tax on rental income received from the properties held in the fund.

 

Although you will have to pay these taxes on a personal level as an investor there are still ways to avoid tax - such as buying a REIT with your pension fund or an ISA. In this case the personal tax payable on rental income may be reclaimed and you will avoid CGT as well. This tax advantage applies on the condition that the REIT fund distributes 90 of its profits back to the investors in the form of dividends. This tax break does not apply when investing your pension or ISA in a managed property fund such as New Star Property or when buying shares in a property company such as Dial Securities. In either of these cases the tax has already been deducted effectively at a basic rate of 20 - and cannot be reclaimed.

 

However the government is looking into this issue and may rule that the same tax advantages that apply to buying REITs with an ISA or pension should also apply to unconverted property companies or property funds. A decision may come before the end of 2007.

 

Another clear advantage of REITs is that they are closely related to the performance of property prices. Residential property prices have risen by 189 in the past decade Source Halifax August 2007. However in mid 2007 various house price indexes all showed signs of a slow down in the residential property market.

 

What is the outlook for property investment

Currently with UK REITs you will have to take the rough with the smooth as the fund will buy a diverse range of property the particular type of which will be beyond your control. Soon however there may be REITs available in the UK that allows investors to focus on one type of property over another. It is already possible to do this with global REITs - in the US for example you may even buy a REIT which invests only in prisons!

 

REITs present even the lowest earners with the opportunity to invest into property - and on a very diverse basis. Unlike unit trusts for example you will not face an initial charge. You will also not pay an annual management fee - around 1.5 is common on property funds. Instead the running cost of the REIT will be factored into the share price.

 

Similarly there is no minimum sum of money that you need to open a REIT which you can do online at one of the stock broking websites. As long as it is big enough to justify the initial stock broking costs you may invest what you like although investing sums under £1000 may not make economic sense.

 

What are the disadvantages to REITs

REITs come with their problems too. Firstly as they are quoted on the stock markets they are a lot more volatile than regular bricks and mortar funds. This is because as well as REITs having their own Net Asset Value NAV they also have a share price value which of course fluctuates.

 

REITs prices may fall simply as a result of negative sentiment about the property sector even if actual property prices hold steady. In other words despite the fact that the asset is the same the psychology means that share prices have fallen - something that cannot happen when investing direct into bricks and mortar.

 

REITs are also focussed more on growth than income which is a good trait overall but when it comes to the property sector many investors are looking for an income - and this would be more conducive to a straight forward property fund.

 

Which is the right REIT for me

Because they structured as investment trusts REITs are able to borrow which is something that unit trusts cannot do. The amount they can borrow will depend on a pretty complex calculation. It is a percentage of the value of its assets which is subject to rental profits as a company being 1.25 of the loan interest payable. In short the maximum this can be is typically between 60 and 70.

 

Where the REIT appears on this scale of borrowing is known as gearing. The more a company borrows the more risky the investment. If you are confident about the long term future of property a high gearing is a good thing if you are not you should choose a low gearing. If you choose a gearing too high for the performance of the REIT you will suffer compound losses and if you choose to low you will not make the same returns as you could have done. Gearing is therefore a prime consideration when choosing which REIT to opt for.

 

As soon as the UK REIT market moves outside its infancy and more types of funds are available you will also have to consider if you want your investment to focus on one type of property - factories for example - more than another. Currently though this is one variable you can strike off the list.

 

Are REITs popular investment choices

REITs experienced a shaky start from their inception in January 2007 according to industry commentators. This is mainly because of the cooling of the housing market during 2007 but also because when clients hold REITs in a tax-efficient ISA or pension wrapper as they are inclined to do it can increase their cost.

 

However it is early days for the products and when regarded as a long term investment they are tipped to do well but as with any investment this is not guaranteed and investors should be satisfied that REITs are suitable for them before investing..

 

The term to describe how closely investments are linked to the stock market - or the extent to which they move in the same direction as the stock markets - is correlation.

 

REITs have around a 60 correlation compared to standard bricks and mortar funds where the correlation is around 20.

10 September 2007

 

Back

2009-03-09 16:25:57 © Moneyextra.com

Moneyextra.com recommends you take independent financial advice before acting on any article