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Investing In REITs – A Guide To Going About It

Real Estate Investment Trusts An Interesting Option But Homework Needed

by Xavier Basil

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What’s A REIT and How Do I Buy In?

For the prospective investor in publicly-traded real estate investment trusts – REITs – there is the need first to understand the nature of the investment and then to sort through what at first sight is a bewildering array of possibilities, processes which may be daunting to some. In this piece, we take a look at what a REIT is and at the ways of getting into this interesting form of property investment. The focus is very much on ‘publicly-traded’ REITs – privately-owned property companies and those traded off-market are not readily available to the typical retail investor and anyway lack the liquidity – the ease of buying in and selling out – which is the hallmark of the listed REIT. In a separate piece we’ll look at the criteria by which you should judge a REIT for investment purposes.

First, some salient explanation of the publicly-traded real estate investment trust. Despite the word ‘trust’ in this label, a REIT is a normally-constituted company whose securities – often called ‘units’ rather than shares – are listed on a stock exchange. The company may be ‘closed’, meaning that any share issues after the initial flotation must be approved by existing shareholders, or ‘open-ended’ which, as with ordinary listed companies, means that future share issues – with attendant share capital dilution – are at the discretion of the board of directors.

To acquire REIT status, the company must conform to a set of legal and procedural rules which dictate (a) the type of business it operates and (b) its ownership structure. In essence, a REIT must generate the bulk of its income – the minimum is typically put at 75 percent – from rents on property owned by the company and it must pay a specified minimum – normally 90 percent– of that income, net of operating expenses and overheads, to its investors each year. As for shareholding structure, the rules in general terms are designed to ensure a broad spread of owners, with no one person or group able to dominate, and by that token an active market in the REIT’s securities.

Tax Neutrality – The Key Point of Difference

Whilst the rules differ in detail from one country to another, and there are other restrictions (such as in relation to borrowing), this same basic framework applies to REITs the world over. And once REIT status has been conferred, there is a uniform tax treatment of such companies. They are treated as ‘pass-through’, meaning that the income earned from approved activity is tax-exempt in the company’s hands, thus avoiding the double taxation which, absent special rules, applies with a conventional company’s earnings – first as corporate income tax and again on dividend paid to shareholders, in each case at whatever is the going rate in the country of domicile.

It’s this tax ‘neutrality’ which differentiates the REIT from other property companies. In principle, the pass-through should make a real estate investment trust more attractive for investment purposes than a conventional property company – it pays no tax on its primary income so that, all other things being equal, more of that income is available for distribution to its owners than is the case with conventional companies.

Bottom Line Difference Not So Marked

The point shouldn’t be taken too far though. The extent to which a REIT’s pass-through status will translate into a higher investment return is very much dictated by the tax regime in the REIT’s – and the investor’s - country of tax domicile. For example, because they pay no tax on their income, REITs cannot attach ‘imputation credits’ to their ‘PIDs’ – property income distributions - and those payments don’t attract the lower tax rate applied in some countries – such as the UK – to dividends, meaning that the distribution is likely to be taxed at the full marginal rate applicable to the recipient shareholder.

In January this year, Deloitte Real Estate published a helpful comparison of the UK tax treatment of investors in REITs as opposed to conventional companies. Assuming the latter pays corporate income tax at the full rate of 24 percent, and assuming individual as opposed to corporate investors, the net benefit to the REIT investor over the conventional company shareholder is 5.3 percent in the case of income taxed in the ‘basic’ and ‘higher’ tax bands, and just three percent for the REIT investor with income in the ‘additional’ band. The real beneficiaries of REIT tax treatment are investors which pay no tax on their incomes – notably UK pension funds and ISAs (individual savings accounts). According to the Deloitte tables, an approved ISA investment in a UK-REIT will better by 31.6 percent the return available to a conventional company shareholder.

The Ordinary Investor’s Way Into Property

Aside from tax though, an investment in a real estate investment trust provides the typical ‘retail’ investor with opportunities to get into property investment which are otherwise limited to high net worth investors. Indeed, this pooling of small investments to fund a large one is the raison d’etre of the REIT. In principle, a REIT could own a single very large – in terms of rental income – property but in practice almost all REITs in all countries where they operate have a portfolio of several – or a great many – properties. These may be in a discrete real estate sector – be it office accommodation, High Street shops or self-storage, for example – but for the most part REITs are diversified at least to the extent of holding a mix of office and retail properties.

Finding Out Stuff About REITs

So where might prospective REIT investors go in order to gauge the range of possible destinations for their investments? If the investor is flying solo at this stage, and the search is confined to UK-REITs alone, a good a place as any would be ‘Reita’, the REIT-dedicated website of the BPF – the British Property Federation – at http://bpf.org.uk/en/reita/index.php There is a page listing all the current UK-listed REITs – some 24 of them - and clickable links to information about each. And since, at least till the rule changes mid-way through last year, all UK-REITs had to be listed on the London Stock Exchange, there’s useful information to be had at the LSE’s website, including of course current trading data on those 24 companies.

Another useful source of information, especially performance-related, on the UK’s real estate investment trusts is accounting firm BDO’s publication ‘UK-REIT Survey 2012’. There’ve been some changes to the line-up since last year – London & Stamford Properties recently merged with Metric Property Investments to form Londonmetric Property (LON:LMP), the REIT formerly known as Capital Shopping Centres recently rebadged itself as Intu Properties (LON:INTU), and at the beginning of this month listed self-storage operator Safestore Holdings (LON:SAFE) converted to REIT status. But otherwise the BDO survey makes for interesting and informative reading.

Looking Offshore

But there’s a much bigger REIT ‘universe’ available to UK-based investors and indeed, the domestic UK market is pretty small in relative terms. Those 24 companies – plus a further two registered offshore – have a current market capitalisation of around £25.5 billion, making the whole UK market just 70 percent in value terms of the largest US-REIT, Simon Property Group Inc (NYSE:SPG), currently valued on the NYSE at $54.81 billion (£35.94 billion). There are over 200 listed REITs in the United States, and their tax-neutral activities are not – as in the UK – restricted to receiving rents. Amercian REITs may also lend on mortgage security, or have a mix of rental and interest income, and there is much greater diversification and specialisation as to property sector in the US market. For example, whereas there is virtually no UK-REIT investment in housing, a number of American REITs are focused primarily or exclusively on residential real estate, including niche areas such as student and military accommodation.

And of course there is a dedicated US-REIT website – www.reit.com – with a huge amount of information available for research purposes.

Beyond the United States, real estate investment trusts are now an established part of the property sector in several countries, notably Australia and New Zealand (where they’re known as unit trusts), Japan, Singapore, France and Germany. In the latter case, the enabling legislation has been in place only since 2007 but German stock exchanges now have more publicly-traded REITs than any country other than the United States, many of them being secondary listings – in Frankfurt or Berlin typically – of REITs domiciled in another country.

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