A REIT, or real estate investment trust, is a listed company (or group of companies) which enables private investors to gain exposure to a portfolio of income-producing properties.
For an investor, a REIT represents a straightforward and tax-efficient way to profit from real estate without buying outright. For a company, REIT status means access to capital which can be used to purchase property and expand business operations.
How do REITs work?
REITs work in the same way as mutual funds, with a number of private investors contributing their own capital to create one single pool of funds. The company then uses this to build a portfolio of properties, whose income is almost wholly distributed among its shareholders on a regular basis. REITs are therefore a long-term speculation, ideal for yield investors.
They were established in the UK in 2007 to give investors a means to indirectly acquire ownership of real estate assets, including residential properties, office buildings, commercial warehouses, high street shops and more. Since then, REITs have proved a key catalyst for the property sector: more than 80% of UK-listed property companies – across a variety of sectors including industrial, commercial, residential and accommodation – have now converted to REIT status.
REITs vs shares
Just like a stock, a REIT is traded on an exchange, rises and falls in value and distributes dividends to its shareholders. So why might you invest in REITs over shares in a property company?
In short, because it is much more tax-efficient to do so. Investors in property stocks are taxed twice: first, to cover corporation tax levied on a firm’s profits, and second, directly on the dividends they receive. REITs, however, are granted special status. They are exempt from corporation tax, meaning a shareholder will only ever be taxed on dividend income.
If a property company doesn’t convert to REIT status, it may be that simply doesn’t meet the requirements and isn’t eligible for these tax breaks.
What are the benefits?
There are a number of reasons investors may choose to invest in REITs:
- High yield: They are required to distribute at least 90% of their profits to shareholders.
- Tax-efficiency: They are exempt from corporation tax, which means shareholders only pay tax on dividend income.
- Liquidity: They can be traded easily via a stock exchange.
- Low cost of entry: They don’t require a substantial outlay, so won’t tie up all your capital.
- Diversification: They give investors access to commercial property that would otherwise be off limits.
What are the risks?
A REIT is dependent on both the performance of its particular sector and the geographical region to which it’s exposed. If either of these suffers, so will your REIT.
As with any investment, it’s crucial you do your homework. Understanding which commercial sectors are on the up, as well as the economic landscape of a particular region and how the company itself is performing, are all key to knowing which ventures stand to do well.
And just like any other investment, some REITs offer higher risk in exchange for bigger potential gains, while others are much more suitable for those looking for safer, long-term returns.
