What are Real Estate Investment Trusts (REITs)?

What are Real Estate Investment Trusts (REITs)?

What are Real Estate Investment Trusts (REITs)?
REITs are companies which own income producing properties. They aim to selectively develop, invest, improve or redevelop properties with a view to generate regular cash flows and distribute this back to its investors.

This insight attempts to answer the following questions: -

  • What is a Real Estate Investment Trust (REIT) and how does it work?

  • What are the advantages of Real Estate Investment Trusts (REITs)?

  • What are the disadvantages of Real Estate Investment Trusts (REITs)?

  • Are Real Estate Investment Trusts (REITs) a good investment?

There are many different types of REITs some of which invest exclusively in healthcare, office, industrial, residential properties, etc.

They are part of Alternatives asset class which are different from the traditional asset classes like Equities, Fixed Income, etc. Investors get diversified and indirect exposure to income producing properties. Alternative asset class provides good diversification potential to investors as they have less corelated with traditional asset classes.

RETIs are required to distribute at least 90% of their income back to investors and they can claim exemption from Capital Gains Tax (CGT) and corporation tax liabilities. Consequentially, investors pay tax on dividends and any capital growth at their marginal tax rates.

Comparing physical property and publicly traded REITs.

Publicly traded Real Estate Investment Trust Physical Property
Liquidity
Highly liquid as shares are traded on the stock exchange. Highly illiquid as it typically takes a long time to close a purchase and sell existing property.
Entry Costs and Overheads
  • Transaction fee to buy/sell
  • Stamp Duty Reserve Tax @ 0.5%
  • Some REITs charge entry fees between 0% to 10% most of which is waived if investing through a tax wrapper.
  • Stamp Duty Land Tax (can be higher if buying property which is not your main residence)
  • Agency commissions
  • Mortgage deposits
  • Expenses to furnish the property
Ongoing Costs
Annual management fee typically between 0.5% to 3%.
  • Expenses for maintenance and upkeep of the property
  • Electricity and water expenses
Taxes
Capital gains tax. If invested through a tax wrapper, no capital gains taxes apply as per current tax rules.
  • Council and local municipal taxes
  • Capital gains tax (if not your main residence)
Diversification Potential
Investment is typically distributed across range of properties owned by the company. Investment is usually concentrated in a single or handful number of properties
Management
Professionally and actively managed. Charges are part of annual management fee. Involves close and direct supervision which may not be possible for some investors. Alternatively, some agencies offer management services for an additional fee.

4 Surprising Drawbacks of REIT Investing You Never Knew About

Taxation

Unlike physical property ownership, REITs cannot pass on tax losses to investors as this cannot be deducted from their taxable income. An investor can realise such losses only by selling shares of REITs at a loss.

Control

Publicly traded REITs do not offer the ability to oversee the day to day running of properties unlike physical properties where investors also have greater control of being involved in investment related decisions.

Price determination and volatility

Publicly traded REIT prices are determined by stock price movements on the stock exchange and are therefore more volatile than physical property prices whose prices are appraised by an independent evaluator.

Highly leveraged

REITs typically borrow to finance their operations and to also refinance their maturing debt. This makes them highly leveraged and riskier than physical properties.