The government is levelling the playing field between overseas corporate investors and domestic investors, leading some to start looking at tax-efficient alternatives – which could bring REITs into the spotlight.
From April 2019, foreign owners of UK property will be subject to capital gains tax when they sell commercial and residential investment property, which they are currently exempt from. Although this may seem a long way off to some, many investors will be thinking ahead and considering their options.
The benefits of REITs
Real estate investment trusts (REITs) are one such option. First introduced in the UK in 2007, they are companies that invest in properties, the shares of which can easily be traded on the stock exchange. They are exempt from corporation or capital gains tax, making them an attractive choice. To qualify as a REIT, a minimum of 75% of the company’s profits must be from property rental, and three quarters of the assets must also be involved in the property rental business.
Compared to buying direct property, aside from the time that can be saved from the extensive research and legal implications involved, transaction costs are much lower as only 0.5% stamp duty is incurred by the investment as opposed to up to 4%.
REITs must also pay out 90% of their rental income to investors as dividends, and many of them have long-term tenancy agreements, which can make the income generated from them more reliable – although, as with any investment related to property, there are no guarantees.
Well-known REITs include British Land, which owns huge shopping centres including Meadowhall in Sheffield as well as significant residential units in London, and Unite Group, which is one of the UK’s largest providers of student accommodation across 28 cities.
Risky business?
Alex Moore, research analyst at Rathbones, points out some of the risks involved when considering investing in a REIT.
“Investors looking to new REITs as a potential source of income should be aware of the risks, such as political and regulatory changes,” he said. “Although not a great concern in the short term, the residual value of property assets should also be considered. For example, will the tenants or asset operators want to rent the property at the next lease break?”
The property market directly affects the performance of the trusts, so while long-term returns can be strong, they can see short-terms falls as well. If interest rates increase, demand for REITs could go down, which has happened in the past and is something else to consider when choosing which investment option to take.
However, it is still likely to be a solution for some institutional investors as the UK’s tax regime potentially becomes less attractive than it has been in the past. According to Seeking Alpha, the best strategy is to focus on REITs with strong portfolios, high-quality tenants and good growth potential in order to secure the best income.
