In and Outs of REITs

In and Outs of REITs

Permission for UK Real Estate Investment Trusts (REITs) to launch in January 2007 was one of a series of changes to the property investment scene brought about by the UK Treasury in the last few years. It follows the change in unit trust rules in March 2004 that allowed unit trust funds to be 100% invested directly into property. In December 2005 these funds were opened up as an option for ISA purchasers.

Investors have had to wait over three years since Gordon Brown first announced that REITs were being considered in order to give savers another way of investing in commercial property. Last year the Chancellor made a last minute decision to exclude direct investment in property from the new self-invested pension plans (SIPPs) with the exception of halls of residence and property syndicates above a certain size.

When looking at alternatives to direct investment in property the field is now looking fairly full and it’s helpful to distinguish between the different species and sub-species and their different strengths and weaknesses.

Property Investment Companies

First in the list are property investment companies. Share price services such as Thomson Datastream show that there about 50 property companies listed on the LSE main market’s property sector with a further 90 quoted on the AIM market. Some of the leading UK property companies (10 of them by mid-February) had metamorphosed into REITs but, confusingly, they still appear with as property companies of the share price pages in the newspapers.

Unit Trusts – Onshore Investment Funds

Secondly, there are the onshore investment funds (unit trusts) mentioned above that specialise in property; for example, Norwich Union Property. Norwich Union Property was established in 1991 and invests in property directly as well as having a (relatively small) proportion of its investments in property companies. Funds investing heavily in property shares will tend to be less risky but at the same time slightly less profitable.

One consideration for investors in property unit trusts is that the fund will be paying tax on its rental income and will be deducting dividend tax at source. Last autumn Norwich Union also launched an overseas property fund with a brief to invest in 50 to 75 investment trusts covering Australia, North America and Continental Europe. The Investment Management Association (IMA) includes property investment funds in its “specialist” sector.

Property Investment Trusts

The third type of investment vehicles are the property investment trusts such as TR Property and the more commons offshore investment trust. The latter tend to be based in the Channel Islands or the Isle of Man but it’s important to remember that, though they enjoy offshore tax advantages, the actual investments they are making are generally in the UK.

When considering investing in an investment trust as opposed to an investment fund it is important to remember that, firstly, the share price may vary from upwards or downwards from the value of the trusts property investments and, secondly, that trusts are allowed to borrow; a highly geared trust has the potential to exaggerate profits or losses depending on the trust’s managers skill in reading the property market.

According to REITA, the trade association for REITs and Quoted Property vehicles there are now 13 UK REITs. They define REITs as follows:

“A REIT (pronounced “reet”) is a quoted company that owns and manages income-producing property, either commercial or residential. Most of its taxable income (at least 90%) is distributed to shareholders through dividends, in return for which the company is largely exempt from corporation tax.”

The Low Down

If one takes one or more of these roads to the property market instead of opting to make a direct property investment, one of the main factors to weigh is that in order to succeed the investment is going to require some knowledge in assessing the management skill available to the REIT, property company, unit trust or investment trust. The skill of assessing investment acumen is different from the expertise required to make one’s own property investment directly.

Also, although the ability to spread risk is a prime inducement, unless your investment choice has numerous and very varied holdings with a wide geographical spread, you still need to make a call on which markets to go for. In fact there are investments with a global reach; Henderson Global Property, an investment trust and seven-month-old First State Global Property Securities, an investment fund for example. As the name suggests, the latter invests in property shares whereas Henderson Global Property invests in a combination of property and property shares

To place in the scales against direct property holdings is the received wisdom that the income from a typical resort type investment will not normally cover the cost of financing the purchase and management and resort fees. This means that appreciating property prices will have to do all the work if the investment is to be worthwhile from a strictly financial point of view. With the current storm clouds over the Spanish property market the need to tread carefully to achieve this is all the more apparent which brings us back to need use discrimination in choosing which market to invest in.

Finally, when deciding on property investment vehicles, bear in mind that 2006 was a very successful year in a sequence of good years for property. The best investment fund in 2006 for example, Aberdeen Property Shares, showed an increase of 145.8% over the year and the specialist sector as a whole has seen the largest volume of new money of any type of unit trust.

Financial advisers and investment experts tend to agree that property should have a place in every portfolio with the cautious investor holding slightly more of this type of investment than one would see in a balanced portfolio. That said, last year’s performance would have pleased a risk-friendly investor, too. However, the signs are that the same level of success is not going to be repeated in 2007.

Comments from investors who switched to investing in investment funds or REITs would be very welcome as would experiences of REITs in countries where they are longer established, such as the USA, or becoming available just now, such as Germany.