What’s the deal with REITs?
Both retail and institutional investors, large and small, have been taking advantage of a more accessible and tax efficient way of getting started in property investment without having a large chunk of money tied up – or getting their hands dirty in its day-to-day management.
Intrigued? Let’s dive in…
(And just to be clear: I’m not a financial advisor, so you shouldn’t read this as advice for your particular situation – I strongly recommend that you seek financial advice before making any investments).
What is a REIT?
A Real Estate Investment Trust (REIT) is an investment company specifically created to invest in property assets on behalf of a diverse pool of investors, but in a tax efficient way. Their aim is to buy and manage commercial or residential properties which they can eventually sell on at a profit – but primarily to provide a strong rental income.
Unlike other property investments, you can easily trade a REIT interest on the stock market in exactly the same way as any other share. Some REITs will focus on a specific sub-sector within the property industry (e.g., student accommodation, shopping complexes, or logistics warehouses), while others will have a portfolio that covers all major asset classes: residential, commercial, or industrial.
REITs also have a proven track record for attracting international investment. Which is precisely why it’s usually advantageous for a property company to convert to REIT status – we’ll explore this in more detail below.
A brief history of REITs
The concept of a REIT has its origins in the US. Back in 1960, the Congress of that time passed new laws which would allow a greater number of investors (especially smaller investors) easier access to income-producing real estate assets through a combination of stock-based investment options.
The point of this inclusive approach was to allow average Americans the possibility of enjoying the same benefits that were previously limited to high net worth individuals and large financiers.
Since then, the US (along with other countries) has refined and enhanced the concept. Now, 40 countries around the world, including the UK, have established REIT regimes and/or similar structures in place.
In the UK, the government set out the rules for REITs in the Finance Act 2006. This came into effect at the start of 2007, and since then many large, listed UK property companies have converted to REIT status – this is alongside the emergence of more “start-up” REITs.
There are strict and lengthy rules associated with gaining REIT status in the UK. I won’t go into all of them, but it’s important to note:
- the REIT’s parent company has to be a UK tax resident (it can be registered elsewhere, but must pay corporation tax in the UK);
- its shares must be publicly listed on a recognised stock exchange;
- it can’t be a ‘close company’ (meaning it’s controlled by 5 or fewer shareholders), and no one shareholder should own 10% or more of the shares;
- at least 75% of its profits must come from property rental;
- 75% of the company’s assets must be involved in the rental business; and
- it must pay out 90% of the rental income to investors each year.
But in exchange for a REIT operating within these boundaries, there are lots of benefits that make the process worthwhile…
The benefits of investing in a REIT
REITs provide straightforward access to the property market for both large and small investors. This is significant because direct property investments are often highly “illiquid” (more on that in a bit) and can be expensive to maintain, making them tricky to sell at a profit later.
Despite their relative ease, REITs are attractive to both retail and institutional investors. Let’s look at why in more detail:
Diversification and Access to High Value Assets
While your typical investment portfolio might comprise investments in other company shares and/or government or corporate bonds, REITs are a whole different ball game.
Without the hassle – and significant financial outlay – of buying and owning physical properties directly, REITs give you indirect access to property investment vehicles in a plethora of different real estate sectors around the world.
Some of these investments would otherwise be limited to large institutions and high net worth individuals – for example, high value and niche asset classes like shopping centres, industrial properties, leisure and hospitality properties, and healthcare properties. But investing in a REIT lets you play in the big leagues!
To reduce the risk, a REIT will typically spread its investments over several properties, and perhaps types of properties, which can help mitigate the highs and lows of each investment at different times. As rental returns don’t necessarily mirror either stock or bond returns, they can offer much-needed stability across your wider investment portfolio.
With that being said: the caveat here is that REITs are still stock market instruments. If the entire stock market goes down for whatever reason (like, say, a global pandemic or financial crisis), your listed shares will probably be affected too.
Tax Benefits and Cost Efficiencies
To encourage ongoing investment in the UK property market, REITs have the benefit of being able to avoid corporation tax on their property investments. Inside the REIT itself, profits and gains are tax-exempt.
It’s not a free ride though, as the investor still has to pay tax on their dividend income and any capital gains they earn from increasing share value. How HMRC will treat this depends on the investor’s personal tax circumstances – but there are certainly reduced transaction costs compared to those incurred when buying property directly (for example, paying a lower stamp duty on shares vs stamp duty land tax on property).
Earlier, I alluded to a big downside of traditional property ownership: aside from the initial cash injection and ongoing maintenance costs, it also takes time and money to sell your rental property when you’re ready to let go.
A REIT, however, turns your property investment into an easily tradable asset. You can buy or sell your shares online at the literal click of a button using a share dealing platform, meaning you can access your cash sooner rather than later – it isn’t tied up in bricks and mortar.
Regular and Consistent Income
As I mentioned earlier, REITs must pay out 90% of their rental income profits each year as dividends. This makes them an attractive option for investors looking for a sustainable income and competitive capital returns.
Considering a sizeable chunk of profitable investments sit with commercial property leases rather than residential, these tend to offer relatively consistent returns with long-term leases between 5 to 25 years.
Throw in periodic rent increases and the investment should enjoy steady income growth – provided, of course, there’s no breach of contract and that the contracted party avoids bankruptcy!
Some examples of major UK-based REITs
As of June 2021, there are 54 UK REITs listed on the London Stock Exchange, collectively worth around EUR €109.6 billion (around £92 billion), according to the European Public Real Estate Association.
The top five of these are:
- SEGRO (worth EUR €15.3 billion / around £12.9 billion)
- Land Securities (worth EUR €5.8 billion / around £4.9 billion)
- British Land (worth EUR €5.3 billion / around £4.5 billion)
- Unite Group (worth EUR €5 billion / around £4.2 billion)
- Derwent London (worth EUR €4.3 billion / around £3.6 billion)
So, who can invest in REITs?
Say it with me now: anyone can buy stocks and shares in a publicly traded REIT.
I mean, why wouldn’t you want to reap the benefits of property ownership, but without the blood, sweat, and tears associated with being a landlord?
Retail investors like you or I can invest a smaller amount, rather than the tens (or hundreds) of thousands needed upfront to buy a property. And we can cash out at any time.
Institutional investors can load up on REIT assets to diversify and maximise their clients’ overall portfolios.
And international investors can buy into REITs to increase their portfolio holdings in various global markets.
Nonetheless, it’s worth remembering that, as with any investment, REIT assets can’t guarantee you any returns and you could get back less than you originally committed.
How to get started with investing in REITs
I’ve already mentioned that REITs are pretty much treated in the same way as other shares listed on the London Stock Exchange, so you can make REIT investments as normal through any of your preferred online share dealing platforms.
But did you know there’s a perfectly legitimate way to buy REIT assets without having to pay tax on them as a UK resident? And that’s by exploiting your annual ISA allowance – this tax year (2021/22), the total annual ISA allowance is £20,000.
REITs are eligible ISA investments, so buying them via the “wrapper” of a Stocks and Shares ISA means you can skip the tax on both the dividends received and any capital gains due on sale of your shares within your allowance limit.
How’s that for hands-off property investing?!