Whether you are looking at investments in commercial property, or rental income derived from a buy-to-let property portfolio, there are various ways to find income from property in the UK.
One such option is a Real Estate Investment Trust (REIT), allowing ordinary investors the opportunity to draw income from UK commercial property and residential property without having to buy, own, or manage it.
Rather than purchasing bricks and mortar, you can simply open an account with some of the best UK investment brokers to invest in a REIT.
So, how what is a REIT, how does it work, and should you consider investing in one?
What is a Real Estate Investment Trust?
A Real Estate Investment Trust, or REIT, is a single company or group that invests in residential or commercial property.
It will do this by either owning its own property, operating property on someone else’s behalf, or by financing property investment, such as in rental properties.
REITs became an available option for companies in January 2007, when the UK government introduced legislation that brought them into effect.
Many listed property groups converted to become REITs at this point, including some of the UK’s largest property companies.
An example of one of the UK’s largest REITs is Great Portland Estates, a company listed on the FTSE 250 stock market index.
How does a Real Estate Investment Trust work?
REITs were modelled after mutual funds, and function in a similar way. When you invest in a REIT, you pool your money in one company alongside other investors.
Then, depending on the performance of the company that owns, operates, or finances the properties, you will see profit in the form of dividends that are linked to the property company’s profits and how much you have invested.
Dividend payouts are treated as rental income
Crucially, a key feature of UK REITs is that dividend yields are treated as property rental income.
As a result, this means that any profits derived from the property investments won’t be charged at Corporation Tax rates for the company.
However, while the business won’t have to pay Corporation Tax, you may still have to pay Income Tax and/or Capital Gains Tax (CGT) on your profits, depending on how much you earn and how you hold your investments.
What kinds of property do Real Estate Investment Trusts invest in?
The investments contained within a REIT usually depend on what the company or group owns.
Typically, this can include a range of residential properties, including rental properties. It cannot include owner-occupied property.
It may also include commercial property, such as primary health properties or shopping centres.
Most REITs tend to specialise in specific property assets, building property portfolios for the type of investment they choose.
For example, one trust might exclusively be a property rental business, while another only invests in commercial property.
While the majority of REITs are equity-based, there are also some that provide the financing to other companies to purchase property instead. These are known as “mortgage REITs”.
Instead of investing directly in property, mortgage REITs give their money to other businesses looking to buy property.
Then, much like any other mortgage or loan, the mortgage REIT generates income from interest paid by the other company.
How does a company become a Real Estate Investment Trust?
When they are looking to convert, companies must go through a strict process to become a REIT.
First, the process involves a review of the company, determining whether or not the business is able to meet and maintain the various conditions that the REIT regime requires.
Next, they will undertake the full conversion process. This usually involves working with a set of financial advisors to create a detailed work plan for the conversion.
This might include elements such as tax advice, initial public offering (IPO) support, accounting support, and any necessary legal advice.
At this stage, there may need to be some discussion with HMRC to ensure that the company meets the necessary requirements. The business must notify HMRC in writing of the date from which the business will become a REIT.
After this, the company may need help in launching its IPO to receive capital funding from investors.
Finally, the REIT can launch. It will be monitored and managed for compliance reasons throughout its operation.
Ongoing requirements for REITs
After this process is completed, there are some further criteria that UK REITs must continue to meet to keep their eligibility.
Below are just a few of the conditions the REIT must continue to meet. Bear in mind that this list is not exhaustive.
Admitted to trading on a “recognised” stock exchange
REITs must be able to be traded on a formally recognised stock exchange, such as the London Stock Exchange.
Balance of business operations
A minimum of 75% of the REIT’s gross assets, and 75% of its accounting profits, must be related to the property rental business part of the company’s operations.
Rental business conditions
The REIT must hold a minimum of three investment properties.
No single property of these three can exceed 40% of the total value of the investment properties held by the REIT.
One caveat to this rule is that multiple investment properties can exist within one building.
For example, in shopping centres, each unit or floor that can be rented separately is considered to be an individual property.
As a result, a single REIT could potentially own one shopping centre but rent out multiple properties within it.
Distribution of profit
In the UK, the rules require REITs to distribute at least 90% of their taxable income in each accounting period to their investors.
They must also distribute 100% of property income distributions that they receive from any other UK REIT. This prevents a director who owns the other company from receiving more income than they’re entitled to.
The pros and cons of Real Estate Investment Trusts
Now that you know what a REIT is and how a company can become one, it’s important to take a look at some of the various benefits and drawbacks that come with REITs.
Benefits of Real Estate Investment Trusts
The benefits of REITs can be broken down into two separate categories: the benefits for companies, and the benefits for individual investors.
Benefits for companies
All profits and gains within a REIT are entirely tax-exempt. That means there’s no Income Tax, Capital Gains Tax (CGT), or Corporation Tax for the company to pay while the value is held within the business accounts.
Tax is only charged at the point when the money is then distributed to the REIT’s investors.
Of course, as the REIT may also participate in non-property related business, any profits or gains from these activities are subject to Corporation Tax.
Greater exposure to investors
The ability to become a REIT means becoming even more available to investors and shareholders, particularly in the retail market.
REITs are also particularly well-known for the way that they attract international investment. This can open up avenues of funding that the business simply could not have accessed before.
Benefits for individual investors
REITs present a potentially tax-efficient option for investors because it is possible to purchase them through efficient accounts.
You can hold investments in REITs in any kind of Individual Savings Account (ISA). Each tax year, you have an ISA allowance, which for the 2021/22 tax year is £20,000. The money you can make on investments held in ISAs up to this allowance is free from Income Tax and Capital Gains Tax (CGT).
You can hold REIT investments in a Stocks and Shares ISAs, an ISA which can hold investments.
You can also hold REIT investments in a Lifetime ISA (LISA), a dedicated account for those under the age of 40 who want to buy their first home or make an early start on their retirement. You can only invest up to £4,000 each tax year in a LISA. This figure counts towards your overall ISA allowance.
Alternatively, you can hold REIT investments in a self-invested personal pension (SIPP), a private pension where you can choose your own investments.
As the rules are clear from the outset, REITs are also thought of as “tax-transparent”.
As a result of the processes that REITs have to go through in order to achieve the status, most REITs have strong governance values at the board level.
This is good for investors as it means they can be more sure that the company is well run, giving confidence that the REIT will be managed properly and investment decisions will continue to be prudent and sensible.
Potentially high yield for a low price
REITs give access to property investments for individuals who may not be able to afford to buy them outright.
British land and property are notoriously expensive, often making property investments also quite expensive.
There can also be costs associated with managing properties, as well as finding tenants and paying for upkeep if they’re rented.
Meanwhile, REITs present a good chance to get involved in property and potentially see a high yield on their investment for a far lower price than having to buy any of the properties outright.
This makes them a good, accessible property investment option for many people.
Access to a liquid property investment
General real estate investors may be able to make a return on their property over long periods of time, provided that house prices rise and/or they successfully find rental income.
However, to cash in on any rise in the value of their bricks and mortar, they’re subject to the whims of the market.
Furthermore, even if a property does produce a return, there’s no guarantee that they’ll be able to sell it to cash in on their profit.
Meanwhile, UK REITs offer investors access to liquid property investments that they can fairly easily dispose of if they no longer meet the requirements of their portfolio.
This makes them a potentially safer choice than buying their own properties.
Disadvantages of REITs
As with any investment, REITs also come with a range of disadvantages, both for companies and investors.
Disadvantages for companies
As a result of the strict rules over how REITs must distribute 90% of rental income profits to their investors, this means the businesses that run them often find it difficult to achieve much growth.
This high figure significantly reduces company profit and also limits their ability to invest in more property.
As a result, they can be associated with weak company growth.
Disadvantages for individual investors
No control over performance
As the REIT and its managers decide which investments are contained within it, investors have no choice over the properties contained within them.
This means investors have no say in investment decisions and, in turn, have no control over the performance of their investment.
A potentially high tax bill
While REITs are tax-efficient for investors using ISAs or SIPPs, investments in REITs outside of these accounts could incur large tax bills. This is particularly true for those who pay higher- or additional-rate Income Tax, reducing profits by as much as 40% or 45% respectively.
This could severely reduce the amount of income that you might potentially receive from a REIT investment.
How risky are Real Estate Investment Trusts?
As with any investment, there are risks involved when investing in REITs.
In general, property investing typically isn’t thought of as high risk as, even if the stock market dips, you still retain a solid asset.
However, REITs are by no means immune to the wider impact of economic cycles and changes. This means changes in interest rates or big market dips put you at risk of losing money rapidly.
If you want to know whether your personal risk tolerance is suited to investing in a REIT, make sure you take impartial financial advice from a professional financial advisor.
How do I invest in Real Estate Investment Trusts?
To invest in REITs, you simply need to invest in one of the REITs listed on a stock market on the London Stock Exchange.
There are UK REITs available to investors on both the Main Market and the Alternative Investment Market (AIM).
According to Moneyfacts, there are more than 50 REITs available on the London Stock Exchange, with a combined value of around £54 billion.
REITs have share prices just like any other investment which determines how much you need to pay when investing in one.
As with any investment, the greater your holdings, the greater the potential for returns. Of course, this also means that there is a potential for bigger losses and falls in the value of your investment.
Investing in REITs via retail investor accounts
It’s possible to purchase REITs using some of the most popular investment platforms available in the UK.
AJ Bell, Hargreaves Lansdown, Interactive Investor, IG, and many other investment brokers all have REITs available on their platforms.
These platforms all offer various ISAs and SIPPs that you can hold your REIT investments in.
Is investing in property and REITs right for me?
As asset classes go, property investment is a favoured choice in the UK, and REITs are certainly a good, low-cost way to take part in the market.
Property assets are physical and tangible, unlike stocks and shares. As a result, they’re easy to understand for most investors and are generally less prone to big market swings.
REITs allow you to invest in such property without the high costs that are often associated with them.
This makes them a useful financial instrument that can give your portfolio some extra diversification in a set of assets that you may not have had access to before.
However, that doesn’t mean REITs are entirely free from risk. Their position as an investment is more akin to stocks and shares than most property, meaning you could lose value if the market dips.
If you’re not sure whether REITs represent the right investment choice for you, consider seeking financial advice.
A financial advisor will be able to look at your entire financial situation and tell you whether you a REIT is appropriate for you and assess how high risk it would be for you to invest in.
Please note: The value of your investments (and any income from them) can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance. Investments should be considered over the longer term and should fit in with your overall attitude to risk and financial circumstances.
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As a seasoned financial professional with extensive expertise in real estate investments, particularly in the UK market, I bring a wealth of knowledge to the table. I have a proven track record of navigating the intricacies of various investment vehicles, including Real Estate Investment Trusts (REITs). My insights are grounded in practical experience, having successfully guided both companies and individual investors through the complexities of property investment.
Now, let's delve into the concepts covered in the provided article:
Real Estate Investment Trust (REIT)
A Real Estate Investment Trust (REIT) is a company or group that invests in residential or commercial properties. Established in the UK in January 2007, REITs provide an avenue for investors to access income from property without directly owning or managing it. Notable UK examples include Great Portland Estates, listed on the FTSE 250.
How REITs Work
REITs operate similarly to mutual funds. Investors pool their money with others, and dividends are distributed based on the performance of the properties owned, operated, or financed by the REIT. In the UK, dividend payouts from REITs are treated as property rental income, exempting them from Corporation Tax at the company level.
Types of Properties in REITs
REITs can invest in a variety of properties, including residential and commercial real estate. They may focus on specific property assets, such as rental properties, primary health properties, or shopping centers. Mortgage REITs, though less common, provide financing for other companies to acquire properties.
Becoming a REIT
To become a REIT, a company must undergo a rigorous conversion process. This includes a review of the company's ability to meet REIT conditions, collaboration with financial advisors, discussions with HMRC, and possibly launching an initial public offering (IPO) to raise capital. Ongoing requirements include being admitted to a recognized stock exchange and meeting specific business and rental conditions.
Pros and Cons of REITs
Benefits for Companies:
- Tax efficiency: Profits within a REIT are tax-exempt until distributed to investors.
- Greater exposure: REIT status attracts more investors, including international ones.
Benefits for Individual Investors:
- Tax efficiency: REITs can be held in tax-efficient accounts like ISAs and SIPPs.
- Strong governance: REITs often exhibit strong governance values.
- Potentially high yield: Access to property investments with a potentially high yield at a lower cost.
- Weak growth for companies: Strict distribution rules may limit company growth.
- No control for investors: Investors have no say in specific property investments.
- Potentially high tax bill: Investments outside tax-efficient accounts may incur significant taxes.
Risks of REITs
While real estate is generally considered a stable investment, REITs are not immune to economic cycles and changes. Changes in interest rates or market downturns can pose risks.
How to Invest in REITs
Investing in REITs is done through buying shares listed on the London Stock Exchange. Various investment platforms, including AJ Bell, Hargreaves Lansdown, Interactive Investor, and IG, offer REITs. Investors can utilize ISAs, SIPPs, or retail investor accounts for REIT investments.
Is Investing in Property and REITs Right for Me?
Property investment, including REITs, is favored in the UK due to its tangible nature and potential for diversification. However, risks exist, and individual suitability should be assessed. Seeking advice from a financial advisor is recommended to align investments with overall risk tolerance and financial circumstances.
In conclusion, my in-depth understanding of real estate investments positions me to provide valuable insights into the nuances of REITs and guide investors toward informed decisions in the dynamic UK property market.