What is a real estate investment trust (REIT)?

Story by Sam Shaw

MoneyWeek

REITs allow you to invest in various types of commercial property© Getty Images

A real estate investment trust (REIT) is a company (or group of companies) that owns and manages property portfolios, generating income and capital gains for investors.

At least 75% of their global profits must come from property rental income.

REITs can invest in many types of commercial property, such as offices, warehouses, data centres, shopping centres or industrial parks. Residential assets often include student accommodation, apartment blocks or assisted living facilities. They don’t invest in individual houses or flats. They might also hold the underlying land an asset sits on, or a site ready for future development.

What are the risks of investing in a REIT?

While REITs can invest with a broad focus, many take a focused view on one or two sectors, which can introduce concentration risk.

Max King, former fund manager and MoneyWeek columnist says excess supply and limited demand could lead a particular sector into a bear market.

“In that case, not only can net asset values (NAVs) fall but discounts to NAV can open up,” he says.

For this reason, knowing what to buy is the key, which is far from easy.

In King’s view, a specialist investment trust, like TR Property, would be a better option, letting the experts do the asset allocation for you.

You could build your own diversified portfolio of commercial property by selecting REITs from different sectors or countries. Or you may prefer to buy an exchange-traded fund (ETF) that tracks a broad index of property companies.

As with most property-related stocks, the share price of a REIT can be volatile, especially during periods of crisis when they may move more sharply than the wider stock market. But while investing in direct property can come with liquidity concerns (because property can be difficult to buy and sell quickly), as REITs offer investors shares in a stock market-listed company, liquidity is less of a concern.

HMRC estimates around 200 REITs are currently registered. Many large property companies, such as British Land and Landsec, fall into this category

These aren’t just a UK concept; the US, Australia, France and Japan also have similar regimes in place.

How are REITs taxed

REITs differ from standard investment trusts and other property funds through the way they are taxed.

In the UK, companies held inside REITs are exempt from corporation tax on any qualifying property rental profits and capital gains. But the REIT must distribute at least 90% of any rental income (not gains) every year to shareholders, within 12 months of the company’s year-end. These payouts are called property income distributions (PIDs), rather than standard dividends.

PIDs are usually subject to a 20% withholding tax – a tax paid directly to HMRC before you receive payment.

PIDs circumvent the need for corporation tax to be paid on the REIT’s holdings, meaning that shareholders in REITs can receive proportionately more money post-tax than through other property investment vehicles.

Certain types of institutional shareholders can qualify to receive PIDs gross – without the 20% deduction. Some of these include UK public bodies, charities or pension funds, for example.

Not all profits generated are PIDs or capital gains. Properties inside REITs can also generate profits from other activities (sometimes called ‘residual’ or ‘non-core’ activities), which might be interest payments, development or property management. These are usually taxed as ordinary profits, and treated as such. These residual activities must be no more than 25% of the REIT’s total income profits or assets.

When were REITs introduced?

REITs were introduced in the UK in 2007. The idea was to remove the ‘double taxation’ that had previously applied – where the core asset (building or piece of land) – paid tax and then shareholders also paid tax on receipt of any investment returns or income. Now, for most REITs, the tax is only collected when investors receive the payments, at their standard rate of income tax.

So while investors hold shares in the REIT (as it’s a listed company), it means they have a similar tax position to owning the property directly.

They may also be subject to other restrictions, such as caps on leverage, which is the amount they can borrow against their assets.