By Louise Misiewicz
Are you happy with the return from your property portfolio?
What are the benefits of REITs for property investors?
I recently wrote an article comparing the benefits of direct property compared to REITs – which can be read in full here. I’ve had a few property investor clients asking for further information on REITs, so I thought it would be beneficial to dedicate a full blog post to outlining REITs in greater detail.
REIT, or Real Estate Investment Trusts, are a way of developing property within an investment portfolio without directly investing as a traditional property investor. It offers diversity within the portfolio, and can deliver significant returns for the investor.
Some of our property investor clients have become increasingly interested in the benefits of REITs in recent months, and our team of tax specialists are on hand to advise and assist further on REITs.
REITs are essentially companies or groups of companies that manage a portfolio of property to earn profits for shareholders, and their special tax status means that they pay no corporation tax on the profits of their rental business, but they need to comply with a number of conditions set out in tax law.
REITs are traded like stocks on the market, and are property-related assets and can include a mix of investments across residential, industrial, commercial and agricultural property units.
Why should you consider investing in REITs in 2017?
There are downsides to buying properties for investment compared with investment in REITs.
Direct investments can be riskier, more concentrated, management intensive and less cost-efficient. I believe that REITs are a better option for some investors, as they are less risky, diverse, and cost-efficient.
REITs own large and well-diversified portfolios of properties. It reduces investment risk significantly compared to private market investments, which are likely to remain very concentrated. Being concentrated can sometimes lead to higher returns, but it is also clearly a riskier strategy.
For those who want exposure to property, but don’t have the capital for direct property investment, REITs can be a reasonable choice for developing a financial portfolio. REITs have also been accused of developing large-scale ‘institutionalised landlords’ in the past, although the traditional landlord is still responsible for the lion’s share of rented properties in the Private Rented Sector as I write this article. That may change.
I’m sure that many property investors have been reading articles on the rules and regulations around REITs. Some of the key facts about the administration and management of REITs include –
- REITs must pay out 90% of their property income to shareholders every year.
- Income from REITs are treated as property income to the investor, and are taxed accordingly. These dividends are subject to a withholding tax at basic rate income tax, except for certain classes of investors who can register to receive gross rather than net payments. These include charities, UK companies, and pension funds.
- REIT shares can be held in ISAs and Child Trust Funds (CTFs), and the managers of these can receive gross distributions, making these highly tax efficient.
- REITs must be primarily engaged in property investment, rather than in development or other non-property related activities.
- As REITs are all listed property companies, investments in them are generally very liquid.
According to the London Stock Exchange (LSE), REITs are good news for companies because they offer a tax-efficient structure, give access to new investors and capital, and offer acquisition currency.
The LSE also considers REITs to be good news for property investors to diversify their investment portfolios, because they are tax transparent, offer a potentially high-yield return, give access to property for a minimal outlay, give a good level of liquidity as they are easy to buy and sell, and are bound around a strong level of corporate governance.
I would add that some of the other main benefits of REITs currently include:
- Economies of scale – ability to buy blocks of flats rather than just one.
- Mortgage interest is 100% allowable in a REIT, but not as an individual. High rate taxpayers will only be able to offset circa 50% of mortgage interest costs beyond 2020.
- Income is distributed in a tax efficient way – sometimes tax-free via an ISA (which is a significant improvement for high rate taxpayers that directly invest money into residential properties that would pay between 40%-100% of their property income)
- The management of the tenant is taken away, as the REIT will do all of this.
- No need to keep track of individual rent receivable/costs, as the REIT management team do this.
Are REITs a profitable long-term option for investors?
I would say that as an alternative to traditional property investment, REITs are worth considering as an addition to your investment portfolio in 2017. I’m certainly seeing increased interest from my clients.
If you’re unsure how to proceed with investing in REITs, please get in touch with me and my team of property tax experts here for an informal discussion on the subject.
Ultimately, you have to weigh the options with REITs and decide if they fit with your investment model. Some investors prefer a mix of REITs and directly-owned property.
I believe that REITs will over time lead to an increased proportion entering the public markets, providing investors with increased access to high-quality investment in an attractive, tax-efficient and liquid form.
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