What Is a Real Estate Investment Trust (REIT)?

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 do they 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

If you choose to buy shares in a REIT you will not be buying into an individual property but instead putting your money into a fund which buys properties for letting purposes. This eliminates the risks associated with ‘having all your eggs In one basket’ as the fund will own various properties, potentially over various sectors of the property market. So, effectively, you will own lots of tiny slices of many properties. So buying into a REIT is essentially the same as investing in any company but one that specifically owns and manages income-producing property

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’ve invested

What are the tax benefits?

The tax benefits accrue to the companies themselves and thereby indirectly benefiting any investor in the REIT. Basically, as a part of their requirements to be granted REIT status, a property owning company must distribute 90% of their rental incomes directly to its shareholders (REIT holders) in the form of a dividend. In return for this pledge, the REIT becomes exempt from paying any Capital Gains Tax upon any of the properties that it sells which were a part of its portfolio. These tax savings should enable the REIT to consequently pay out more in its dividends than would have been the case without the tax break

As far as REIT holders are concerned, dividends are subject to income tax and any appreciation in the share price is subject to capital gains tax

REITs can be held within an Individual Savings Account (ISA), a Pension Fund (including Self Invested Personal pensions [SIPPS]) or Child ISAs to help make them even more tax efficient

How easy are REITs to buy and sell?

Shares in a REIT are traded on the stock exchange like a normal company. Their value is therefore determined by supply and demand (and general market sentiment), and could therefore be above or below the value of the underlying assets held in the fund. Investment trusts are permitted to borrow money – returns can therefore be ‘geared’. This can increase returns when the manager makes correct decisions, but can increase losses if the money borrowed is used to buy investments that fall in value

Are REITs a good investment?

Commercial property investments can provide a high and potentially rising rental income and some capital growth over the long term. REITs often have long-term lease agreements with tenants, which can help to make rental income and dividends paid relatively reliable. In addition, by index-linking rents or having upward-only rent reviews a growing income can be established

However, they are also susceptible to the ups and downs of the economic cycle. Certain areas could face overcapacity, resulting in falling rents or empty properties that reduces investor income and hinders values

In the short-term, REITs therefore tend to correlate (move up and down in price) somewhat with equities in relation to the economic cycle. They are also heavily influenced by the bond market as demand ebbs and flows for income-producing investments. Yet they do have their own drivers of performance and they can offer diversification benefits over the medium-to-long term

REITs tend to offer a good yield over and above high-quality bonds and most equities, so they are of particular interest to income seekers, though the combination of income and rental growth can be attractive to all investors