Real Estate Investment Trusts (REITS)
How you can avoid tax entirely on your REIT
Although REITs do not pay Capital Gains Tax or tax on rental income received from the properties held in the fund you will have to pay these taxes on a personal level. However, as an investor there are still ways to avoid tax - such as buying a REIT with your pension fund or an ISA. In this case, the personal tax payable on rental income may be reclaimed and you will avoid CGT as well. This tax advantage applies on the condition that the REIT fund distributes 90% of its profits back to the investors in the form of dividends.
REITs present the opportunity to invest into property on a very diverse basis. Unlike unit trusts, for example, you will not face an initial charge. You will also not pay an annual management fee - around 1.5% is common on property funds. Instead the running cost of the REIT is factored into the share price and the buying and selling of shares will involve stockbroking charges. There is no minimum sum of money that you need to invest in a REIT, although the minimum level of fees charged by the stockbroker needs to be taken into account.
Because they are structured as investment trusts, REITs are able to borrow, which is something that unit trusts cannot do. The amount a REIT can borrow will depend on the ratio of profits to loan financing costs. To avoid a tax charge the ratio must not fall below 1.25:1.
Where the REIT appears on this scale of borrowing is known as 'gearing'. The more a company borrows, the more risky the investment. If you are confident about the long term future of property, a high gearing is a good thing, if you are not, you should choose a low gearing. If you choose a gearing too high for the performance of the REIT you will suffer compound losses and if you choose too low you will not make the same returns as you could have done. Gearing is therefore a prime consideration when choosing which REIT to invest in.
As soon as the UK REIT market moves outside its infancy and more types of funds are available, you will also have to consider if you want your investment to focus on one type of property - factories for example - more than another. Currently though, this is one variable you can strike off the list.
Introduction
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