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Are REITs right for you? By Rob Griffin
Real Estate Investment Trusts (REITs) offer investment opportunities in high-profile shopping centres, prestigious city centre office blocks and luxury hotels, providing an alternative way of getting exposure to this exciting asset So what's all the fuss about? The simplest definition of a REIT is a company, in which you can invest, that owns and operates income-producing real estate. As long as it distributes 90% of its income to shareholders, it doesn't have to pay income or capital gains tax (CGT) on its portfolio. While they are new to the UK, REITs have been around for a long time and are already operate successfully in the US, Australia, Belgium, Canada, Singapore, Japan and France. To understand the enthusiasm for the introduction of REITs in the UK, it's important to look at what's been going on in world property. We all know how much house prices have risen in recent years, but commercial property has been booming too. As well as the prospect of the bricks and mortar rising in value, commercial property has the added attraction of the yield generated by tenants. Best performers Even though equities performed the best during 2005 with a 22% return, property wasn't far behind at 19.1%. Within commercial property, offices delivered the most at 20.4%, while retail returns weighed in at 18.8% and industrial at 18.4%. Of course, it has long been possible to invest in commercial property. While wealthier investors can buy properties themselves the rest of us can buy shares in property companies or invest in funds that pool investors' money to buy up a portfolio of properties. Recently, the latter has been an incredibly popular option with investors, particularly since they became eligible for individual savings accounts (ISAs) at the end of 2005. In one month alone - September 2006 - £381 million was invested into property funds out of the £1.5 billion ploughed into equities, according to figures from the Investment Management Association. Many of the specialist funds which invest mainly in bricks and mortar have done extremely well. The New Star Property unit trust, for example, delivered a 17.3% return in the year to 6 November 2006, according to data compiled by Standard & Poor's. Three-year figures to the same date are even more impressive, with a 53.8% return. Similar figures have been recorded by the Norwich Union Property fund. But both ways of investing have their downsides. Buying shares in property companies is not particularly tax-efficient due to the problem of double taxation. As well as the companies having to pay corporation tax on their profits, investors are hit when they receive any dividend payments. Lack of diversity Critics of bricks and mortar funds also point to the relative lack of diversity of holdings and a lack of liquidity. Even for a fund with billions of pounds under management, critics say there will always be a limit to how many actual buildings this money can buy. Meanwhile, liquidity can be a problem when investors want to get their money out. To liberate substantial amounts of cash would require selling off some of the fund's assets and anyone who has sold a house knows how long that can take. This is where REITs fit into the equation. They aim to give a wider range of investors access to property as an asset class through a more liquid, transparent and tax-efficient vehicle than has previously been available.
The new regime is also beneficial to existing property companies that are converting to REIT status because of the tax incentives. In exchange for paying a one-off charge equivalent to 2% of the market value of their rental properties, firms won't have to pay any income or CGT arising from their portfolios. Portfolio benefits That's great for companies, but what benefits can REITs give your portfolio? Are they a terrific way to enjoy double digit returns or is there a risk that they have been hyped out of all proportion? The principle advantages of UK REITs are liquidity - the ability to buy and sell quoted investments easily and with low charges; high income distribution; and tax transparency and exposure to a wider spread of investments. Patrick Sumner, head of property equities at Henderson Global Investors, insists that property shares provide investors with plenty of benefits compared with funds that are buying actual bricks and mortar - despite additional stockmarket volatility. However, Richard Hunter, head of UK equities at Hargreaves Lansdown, says that it's vital that investors understand that even though the underlying asset is property, REITs are traded as shares, which means that they would be effected by a fall in global share prices. This makes them riskier and for many people the appeal of commercial property to date has been that they behave differently from shares and therefore spread the risk in your portfolio. Darius McDermott, managing director of Chelsea Financial Services, agrees that investors will have to accept that REITs are also going to have some equity-type characteristics. "It's all about having a balanced portfolio and making sure that the investments you've got are suitable for your particular requirements." However, the property boom - in both the commercial and residential sectors - has left many independent financial advisers worried that the good times could be over. Investors certainly shouldn't expect a repeat of the bumper performance enjoyed in recent years, but it could still be a decent long-term investment. Global REITs Of course, you don't have to focus all of your attention on the UK market as there are plenty of opportunities to get access to global REITs. Asia, for example, is being tipped as the area likely to offer the best returns over the coming years. This potential has been identified by Norwich Union, which has designed a Global Property fund with the stated aim of achieving capital growth by investing globally in listed REITs and real-estate securities. Around 80% of the portfolio is invested in REIT-type companies, spread across 13 countries and the main property sectors - offices, retail, diversified, residential, industrials and hotels. So what's likely to happen? Will UK REITs take off in a big way or will it be more of a slow burn? A survey by the Association of Investment Companies found that 40% of sophisticated investors were considering investing in REITs, a further 35% viewed them as a low-cost way of gaining access to a potentially lucrative property market, and 27% thought they were safer than direct property investment. But investors need to be cautious, suggests Mandy Bradley, director of propertyforecasts.co.uk, a specialist website that predicts property price movements. She advises investors to carry out as much research as possible before taking the plunge. "We feel that REITs may be a good thing in that they offer a relatively stable, secure investment that should be appealing to investors, but the rules of investment still apply when you're thinking about property portfolios," she says.
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