Real Estate Investment Trusts (REITs) were first established in 1960 in the USA to enable smaller investors to access larger-scale property investments. A REIT is a company that earns the majority of its income from property investments and distributes the majority of that income back to its shareholders. More than 20 countries around the world have now established REIT regimes and they have become attractive vehicles for raising capital from domestic and international investors. The UK REIT regime launched on 1st January 2007 with a number of the larger listed property companies converting to REITs almost immediately.
There are now over 40 UK REITs, being a combination of established property companies that converted to REIT status, some examples being British Land, Land Securities and SEGRO (previously known as Slough Estates) which are constituents of the FTSE-100, Tritax Big Box REIT plc which is in the FTSE-250 and an increasing number of start-ups. Some fund management companies, e.g. Schroders, have also set up REITs.
REITs enjoy substantial tax benefits as they are exempt from corporation tax on profits and gains arising from their property rental business. They do however need to comply with a number of conditions. First, its structure must be approved by HMRC. A REIT must hold at least three properties of which no single property can exceed 40% of the total value of those in the property rental business segment of its portfolio and a minimum 75% of its gross assets must relate to the property rental business. Importantly, it must pay out at least 90% of its property income as well as 100% of any income distributions received from other UK REITs. Capital gains can however be retained by the REIT. There are also conditions on controlling stakes in the company and it must comply with specific financial ratio thresholds. Failure to comply could lead to a loss of REIT status and/or tax penalties.
There is also a requirement for REITs’ shares to be admitted to trading on a recognised stock exchange. Newer companies tend to list initially on one of the cheaper stock markets, such as The International Stock Exchange where around 25% of UK REITs are listed, and then move to the premium London Stock Exchange when they are more established.
Shares in the company cannot usually be purchased or redeemed directly like those in open-ended pooled funds, but daily dealing on a stock exchange allows a REIT investor to buy from or sell to another investor via a broker – a custody account is useful here. It is worth remembering that REIT shares may trade at a premium or a discount to the net asset value of the business.
REITs tend to invest in a particular sub-sector within the wider property market. Some have a sectoral tilt – industrial (e.g. SEGRO), retail (e.g. Shaftesbury, Hammerson and Westfield), offices (e.g. Great Portland Estates), healthcare (Assura) whilst some diversify across the commercial property sector (e.g. British Land and Land Securities).
More recently, a number of residential property REITs have started up, including Bricklane Residential, Civitas Social Housing, and GCP Student Living. The Fundamentum Social Housing REIT launched in November 2019 and focuses on supported housing or assisted living accommodation for vulnerable adults.
The attraction for investors is the access to wider sectors of the property market, such as office or industrial property, which they may otherwise find difficult and, as shareholders it entails lower transaction costs than the stamp duty land tax which would be paid on directly-held property. Investors in REITs are taxed on distributions from the property rental business as if it was their own property rental income. Since UK local authorities pay no income or corporation taxes, they can receive their income gross.
REITs are non-capital expenditure investments for local authorities in England and Wales, authorities in Scotland can invest and can include them as permitted investments in their strategies after determining their appropriateness.
Another clear advantage is that REITs are eligible to be accounted for at “fair value through other comprehensive income”, meaning that capital gains and losses will not affect revenue. For local authorities in England and Wales this remains the accounting treatment even after the statutory overrides for pooled funds expire in 2023.
Would every REIT make a good investment? Not quite. REITs aren’t immune from market and business sentiment, as the coronavirus pandemic has demonstrated challenging those with portfolio exposure to retail, hospitality and leisure. Intu Properties, owner of some of the UK’s biggest shopping centres, had been struggling even before the effects of the pandemic took its toll and called in the administrators in June 2020. On the other hand, REITs in the warehousing and logistics sectors have reaped the benefits from the seemingly irreversible shift in our shopping habits.
As for any collective investment, analysis of and an understanding of the REIT, its sectoral spread, debt levels and portfolio split between property rental and other income are key. It is worth examining what underlies the REIT’s valuation and yield - pay heed to a high yield which is the result of a steadily dropping share price. What is the tenant make up, what are the sources of rental income and how diversified are they? How consistent has the income been and how will it fare in an economic downturn? How exposed is the portfolio to changing dynamics and trends? And, importantly, as the REIT will be an investment in your strategic longer-term portfolio, does it fit with your risk threshold, time frame, tolerance for volatility and other longer-term investment?
This article does not constitute a recommendation to buy, hold or sell investments in REITs. If you are a Professional Investor and would like advice on this subject please contact us by emailing firstname.lastname@example.org.