The UK’s changing property market
By
Editorial staff
Simon Wilson
Jul 14, 2006
Gordon Brown announced this week that real estate investment trusts (Reits) will soon be available in the UK. Is this good news for investors?
Changed to the UK property market: what are Reits?
Reits are a well-established means of investing in the property market in many countries. They operate just as ordinary investment trusts do, pooling investors’ money and then investing it for them, in this case in commercial and residential property.
In the UK, there are already many property funds (operating both as unit trusts and investment trusts), but the Government’s decision to introduce Reits is still causing some excitement thanks to the fact that they are both more tax-efficient and more flexible than conventional funds.
The UK’s current crop of investment funds are not normally allowed to invest in residential property, for example, and face restrictions when it comes to buying commercial property too. For example, a unit trust must have at least 20% of its assets in property shares (rather than actual bricks and mortar) to help ensure that it is sufficiently liquid.
Changes to the UK property market: what about the tax angle?
Tax is the really big selling point of Reits. When UK investors buy shares in property companies at the moment (either directly or through a pooled fund, such as a unit trust), they face the same ‘double taxation’ that any equity investor faces: companies pay corporation tax on their earnings, then the individual shareholder pays tax again on their dividend income or any capital gains. As a result of this, quoted property companies tend to trade at a significant discount to the asset value of their portfolios, which over the long term acts as a disincentive to investors.
Within a Reit, by contrast, rental income and profits from the sale of assets are free of tax, on condition that the fund distributes most of its earnings to its investors in the form of dividends (in the US, at least 90% of the funds earnings must be distributed).
This privileged tax status means that Reits are, in effect, quoted companies that don’t have to pay corporation tax. This in turn means that a great many listed property companies can be expected to convert to Reit status once the new regime is introduced here in the UK.
Changes to the UK property market: when will Reits arrive in the UK?
As part of this week’s pre-Budget statement, Gordon Brown confirmed that the Government will legislate in next year’s Budget to establish “UK-Reits”. The Treasury’s stated goal in this is “to improve the efficiency of the commercial and residential property investment markets by providing liquid and publicly available investment vehicles for all investors to access” – with the ultimate aim of fostering the growth of new housing in the UK.
Changes to the UK property market: what will UK-Reits look like?
The Government will publish exact details of the proposed tax regime for firms seeking Reit status later this month, but the basics announced this week appear to be same as in other countries. Property firms resident in the UK and listed on a recognised stock-exchange will be exempt from corporation tax on rental income or capital gains, but to qualify they will need to distribute at least 95% of profits to investors (who will then be liable to pay income tax on them).
However, there is still one unknown that could yet spoil the party. To offset the likely loss in tax revenue, property companies seeking Reit-status will face some sort of one-off tax hit (or ‘conversion charge’, in Treasury-speak). However, to the irritation of investors and sector specialists, the chancellor is keeping secret the details of exactly how big that charge will end up being until the Budget next March.
Changes to the UK property market: what this means for the property sector?
It should make it easier to raise capital and could therefore expand the sector dramatically. In the US, Reits tend to trade at a premium, or on a par, with their net asset value, whereas UK property firms usually trade at a steep discount to it, thanks to the disincentive effect of ‘double taxation’. This makes it harder for UK companies to raise capital.
Assuming that once Reits are introduced this is no longer the case, we could see the size of the listed property-sector more than quadruple, says analyst Mike Prew of Citigroup. That’s partly because private companies such as Canary Wharf, and offshore property vehicles, will have an incentive to return to the stockmarket. But it’s also because industrial groups, retailers, hoteliers and leisure firms may well be tempted to spin their property assets off as Reits for tax reasons: there is speculation that large, listed companies, such as Hammerson and British Land, may split up into various sector-specific Reits.
However, the chief executive of the UK’s largest property company, Land Securities, said in October that his company is likely to retain its current shape – albeit as one big Reit.
Changes to the UK property market: should you buy into Reits?
On the face of it, Reits are very good news for investors. They’ll be rather like a property version of an exchange traded fund and should give individuals easy, cheap and tax-efficient access to commercial property for the first time, as well as giving them access to residential property without the hassle of buy-to-let.
However, whether or not Reits are embraced with enthusiasm depends, to some extent, on the details to be announced in the spring. For example, the Treasury might grab the opportunity to include unpopular new regulation as part of the package, such as scrapping upwards-only rent reviews and long leases on commercial property.
The other note of caution concerns asset allocation and diversification. Many UK investors already have more than enough exposure to the property market via their leveraged exposure to their own homes, so investing in Reits too will make them dangerously underdiversified.
Published in Property
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Simon Wilson
