A five minute guide to REITs

Have you heard of a REIT? This acronym stands for ‘Real Estate Investment Trust’ and offers an intriguing way to get exposure to property markets.

Here, we take an in-depth look at these products, explain how they work, look at the benefits they provide, and assess the potential risks being taken.

What is a REIT?

A REIT is a real estate investment trust. These are listed companies that are floated on stock markets in the same way as shares in any other company.

They own commercial or residential property and rent it out. While corporation tax isn’t payable on profits from rental operations, they do have to comply with regulatory conditions. This enables private investors to access a broad portfolio of (hopefully) income-producing properties in a fairly simple and tax-efficient way.

Some REITs can offer access to various property sectors that used to be the preserve of institutional investors with huge financial resources.

When were REITs introduced?

REITs were first introduced into the UK back at the start of 2007 to give people access to property without the hefty tax charges and associated problems with owning buildings. The idea was to create a vehicle that enabled investors to obtain broadly similar long term returns as they would have from investing directly in property.

Previously, such direct exposure to commercial property – such as office buildings or even shopping centres – would have required millions of pounds to buy the actual bricks and mortar. Over the years, the regulations governing REITS have been tweaked to make them more attractive and accessible for investors.

How do REITs work?

There are a number of conditions that a company needs to satisfy in order to receive REIT status, according to an analysis of the sector by Deloitte. “If these conditions are breached, the penalty can range from automatic expulsion from the regime to additional tax liabilities for the REIT,” it stated.

The rules include being admitted to trading on a recognised stock exchange, hold at least three properties, and distribute 90% or more of its tax-exempt income profits.

While REITs have similar rules to investment trusts, there are key differences that you’ll need to bear in mind before getting exposure to this area.

Tax benefits of REITs

The main benefit of a REIT is being able to invest in various parts of the property sector in a straightforward, tax-efficient way. Shareholders in REITs pay income tax, as opposed to dividend tax, on the distributions made to them in this way, according to the Association of Investment Companies. “The general idea is that they are taxed as though they owned the properties themselves,” it stated.

“Of course, if REIT shares are held in an account such as an ISA or a SIPP, no tax is paid on the distributions, making REITs a tax-efficient way to invest in property.”

Conversely, investors in traditional – non-REIT – property stocks are effectively taxed twice. Firstly, through the corporation tax on the firm’s profits and then on the dividends they receive.

Other benefits of REITs

Taxation isn’t the only benefit. There is also the prospect of a high yield by virtue of the fact REITS must distribute at least 90% of their profits to shareholders.

Investors in REITs also benefit from liquidity, given the fact they can be quickly and easily traded on a stock exchange. This makes it easy to buy into a REIT and liquidate your holding if required.

Diversification is another key attraction. Most REITs will invest in a wide variety of properties. This means they won’t be adversely affected should one of their locations run into difficulties.

They also provide exposure to property types that would normally be out of a private investor’s financial reach, such as shopping centres, care homes, warehouses, self-storage, and large office buildings.

Potential risks of REITs

No investment is 100% risk-free – and that’s the same with a REIT. As it’s a publicly traded company on a stock market, it’s susceptible to the usual volatility of such investments. This price could also be affected by poor sentiment towards the property sector as a whole, or the geographical region in which key buildings are located. This means the trust could trade at a discount to NAV – in other words, the share price could be lower than the value of the underlying assets.

Similarly, a REIT could be adversely hit should a certain area, such as retailing, hits problems and sees a marked decline in demand. The level of rent charged – and valuations of the buildings – could also both tumble as a result of such a scenario.

A REIT – like other investment trusts – can also use gearing. This is when the manager borrows money to invest. If the manager gets their call right, this can enhance returns, but if they are wrong, or the market goes against them, it can also increase losses.

It’s also important to remember that the property market – particularly the one in the UK – can be quite cyclical. In other words it is dependent on the health or the economy and the consumer.

That’s why it’s vital to carry out thorough research into prospective REITs before parting with your money. Find out how they operate, their investment objectives, and track record of performance.

Research Elite Rated funds investing in REITs here

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