A Real Estate Investment Trust (REIT) is a group of companies – or even one individual company – which invests in a portfolio of properties on behalf of shareholders in order to earn them profits.
Unlike other companies, a REIT isn’t liable for corporation tax. This is despite the fact it receives rental income for properties. Neither is it eligible for capital gains tax. The reasoning behind this tax relief is that the government is looking to actively encourage companies to invest in UK property. Investors do, however, have to declare the dividends they receive from a REIT, which in turn is regarded as income from property for individual tax purposes. This is calculated at a basic rate of tax (unless the investor is a charity, UK company or pension fund and income is a gross rather than net payment).
The tax angle is a huge incentive, proving extremely attractive to shareholders, and indeed, since they were introduced into the UK in 2007, most property companies (around 80 per cent, in fact) now have REIT status. This includes big names such as Land Securities and Standard Life Investments Property Income Trusts.
Although all REITs deal in property, some tend to specialise even further, choosing to invest in particular sectors, such as healthcare, retail, manufacturing etc. Big Yellow Group, for instance, focuses solely on self-storage, while Assura is all about GP surgeries and primary care facilities in general. Town Centre Securities specialises in mixed use developments (i.e. residential and commercial) near transport hubs in some of the UK’s biggest cities.
Rules of a REIT
What makes a REIT different from other large companies is that it can be traded on the London Stock Exchange. This means that anyone can buy shares in the company. There are certain rules that a company with REIT status must abide by, however. These are:
- Around 90 per cent of the company’s income must be paid out to its shareholders on an annual basis
- At least 75 per cent of the company’s profits every year must be via rental income; at the same time 75 per cent of the assets at any given time must be property rental-related (i.e. property investments)
Benefits of using a REIT
Apart from the corporation tax and capital gains tax benefits, most REIT companies can offer shareholders long-term dividends (since they tend to sign up tenants on long leases; commercial leases in particular can be for 10 to 15 years).
Risks to consider when using a REIT
Many REIT companies have a high level of debt. This is understandable really because, once they have paid out 90 per cent of their profits to shareholders, they don’t actually have a lot of cash left to buy new companies and grow. As a result, they are more or less forced to take out debt if they want to expand (either that or they have to sell shares). This means that were the property market to suffer a slump, and the company’s rental income to reduce as a result, then it may not be able to meet its debt commitments, causing them to spiral. This in turn would affect shares, causing their value to drop and individual dividends (if any) to be poor.