TL: Investment funds, particularly property funds, is an area you are especially interested in. What general information can you give us about real estate investment trusts (REITs) in the UK for those unfamiliar with the UK real estate scene?
SC: First of all, what is a REIT? A REIT is a special type of company in the UK which invests in real estate – buying property and letting it out to tenants. The type of property can be commercial or residential, though at the moment, most REITs are commercial – one of the objectives in introducing the REIT was to support the housing sector in the UK, but that hasn’t really taken off so far.
REITs come in all shapes and sizes. There are the well known blue chip companies like British Land, who are generalists, or more specialised companies such as Primary Healthcare Properties who invests in doctor’s surgeries – very attractive since the rents are Government backed. You can invest in a REIT by buying its shares through a stock market, the London Stock Exchange. Although they were first introduced with a view to getting retail investors interested, they are for everyone – institutional investors both UK and overseas.
Some of your members may already be familiar with the term REIT, for they have these creatures in their own country. Countries like the US, Canada, Japan – the UK is just following everyone else – they have a REIT, so should we!
TL: What are the benefits of investing in a REIT?
SC: Two benefits, both of which are linked.
First of all, a REIT can be thought of as a fund, pooling its shareholders capital and investing it on their behalf. Not everyone has the skill or ability to invest in property – it takes a lot of time and effort doing it on your own. But doing it through a fund means you have access to professional expertise whose job it is to generate returns for their investors. And you have a ready-made diversified property portfolio simply by buying shares in a single company rather than buying them yourself. The fact that the shares are listed on the stock market also makes it easier to access the property market – shares are more liquid than real estate, though how liquid they are will depend on the stock in question.
The second benefit is the tax advantages. REIT’s pay no tax on their rental profits and no tax on their capital gains. The capital gains exemption is something they share with a lot of other UK fund vehicles, but the exemption on income is what gives it an edge. The idea is to shift the tax burden from the fund level to the investor – each investor can be thought of as running his own little private property venture and so he’s placed in the same footing as if he was investing directly. This is achieved by the fact that REITs have to pay out at least 90% of their rental profits to shareholders – they are effectively a conduit for passing on the rent. However, unlike partnerships, capital gains aren’t imputed to investors each time a property is sold – gains are only taxed if and when investors sell their shares.
The tax breaks come with a catch. There are various conditions that a company needs to satisfy – some of them may be so onerous that it’s just not worth it. For example, at least 75% of the business income and assets must come from renting out property – but not all property related activities, such as property development count as property letting – not only are they outside the exemption, but having too much property development could jeopardise the REIT’s status. It’s for this reason that some UK companies such as Helical Bar decided not to become REITs in the first place.
Another factor to bear in mind is that there are stringent rules on the amount of debt cover, though these have been lightened recently. Bearing in mind that property investment is a highly geared form of activity, these rules may hamper a company’s borrowing options.
TL: What kinds of property assets can a REIT invest in, and can they benefit from tax exemption?
SC: The answer is obvious – or at least seems obvious at first! The business is all about letting property to tenants in return for a rent. A REIT is just a glorified landlord. Both commercial and residential property are permitted, though the latter hasn’t been a favourite choice due to what was perceived as the high start-up costs and difficulties in complying with the rules.
But there are in fact other types of indirect investment that a REIT can be involved in. For example, REITs can get together with other institutional investors and invest through partnerships, joint ventures, certain types of offshore unit trust, they can even invest in other REITs – yes, you can have a REIT of REITs, like a fund of funds, though there are conditions attached. A REIT can even hedge its property exposure by taking derivatives.
TL: It seems ironic to you that property investing is currently popular in the UK, whereas until a decade ago there were very few fund vehicles available for both UK and foreign investors. Things have drastically changed, though, in the last decade. What are some of the most common fund vehicle available for UK and foreign investors?
SC: Yes, I have to chuckle when I think of how many TV programmes we have here! How to be a property millionaire and the like – we have a saying in England, “An Englishman’s home is his castle” and certainly after the dot com crash individuals have placed greater importance of bricks and mortar as the “safe bet”
But as I mentioned before, not everyone can do it. Even if you can, there’s a limit to how much you can diversify a portfolio. That’s why investing through a fund is probably more appropriate for a lot of people – in fact, one big advantage is that you don’t have to take on debt to do it, the fund does that for you.
We’ve always had a property vehicle in the UK, in the shape of the limited company, and you could access these though stock markets. The only problem was that it wasn’t tax efficient. And we’ve had the limited partnership which is tax efficient and is still suitable for large or private wealthy investors and large institutionals who want to do things that the publicly regulated companies aren’t allowed to do. And in many ways, partnerships are very suitable for overseas investors who will only be taxed in their own home jurisdictions – I believe Steven Landes mentioned this point in his recent interview.
But the REIT is one of the first vehicles suitable for retailers, as well as the institutionals and overseas investors. They first came on the scene in 2007, and shortly afterwards, the property authorised fund appeared in 2008 – this is an open-ended investment company rather than the closed type, but with the same tax breaks as REITs. Unfortunately there haven’t been that many around since they came on the scene at the same time as the financial crisis hit people’s TV screens!
And only recently we have two other fund vehicles, both under the rubric “authorised contractual schemes (I know, they aren’t the most inspiring names) which are completely tax transparent and suitable for feeder funds.
One last fund vehicle that needs mentioning is the offshore property company located in the Channel Islands, but quoted on the stock market. This is the closest corporate equivalent to a REIT – since they’re offshore they pay no capital gains tax but they do have to pay income tax on the rents. A number of these funds were launched ten years ago, and proved very popular, trading on premiums as high as 20%. In the past year we’ve seen a number of these funds actually coming onshore and converting to REIT status – Standard Life is probably one of the best known names to do this. It will be interesting to see whether this type of fund has a future, or whether new funds will start up from the UK as a REIT.