With market volatility likely to continue for a while, it comes as no surprise that investors have been diversifying their portfolios in a bid to lower their risk.
Property has long been a popular diversifier, partly because bricks and mortar give investors a sense of physical security. However, with bank lending at an all time low, buying property as an investment is not as simple as it once was. Furthermore, those looking to make a gain on their investment are faced with double taxation – capital gains tax at 18 per cent, as well as income tax on the profit.
As a result, investing in property through a real estate investment trust (Reit), has grown in popularity. This is because Reits, which have been around for decades, but were only introduced in the UK in January 2007, offer tax advantages, high yields, and allow an investor to exit on much shorter notice, should markets take a turn for the worst.
A Reit is a security that sells like a stock on the major exchanges and invests in property directly. After paying a fee to convert to Reit status, however, a Reit escapes corporation tax. It must also pay out 90 per cent of its property income to shareholders. Individuals can invest in Reits either by purchasing their shares directly on an open exchange or by investing in a mutual fund that specialises in listed real estate.
Phil Nicklin, Reits and major corporates lead tax partner at Deloitte, argues: “Reits are exempt on rental from investment properties and capital gains tax (CGT) on investment properties, so the first time there is any tax is when the investor receives a dividend on the Reit. If an investor invests in a normal investable company, like a Shell or BP, that company pays tax, and when the dividend is paid out to shareholders the shareholder also pays tax.”
Payouts are subject to a withholding tax at basic rate income tax, except for certain classes of investors who can register to receive gross rather than net payments. These include charities, UK companies and pension funds. Reits can also be held in Isas and child trust funds (CTFs), and the managers of these can receive payouts gross of tax.
Mr Nicklin adds that there are other benefits too. “Reits have the advantage of liquidity – if you want to sell your shares in a Reit you can sell them pretty well instantly on the stock exchange or through a broker, whereas if you owned the property yourself you’d have to market it, and there’s always a lead time to sell. Another major aspect is that by investing in a company which perhaps owns some big private properties, investors can get access to buildings that they may not have been able to purchase on their own.”
Among other things, Reits invest in shopping centres, office buildings, flats, warehouses and hotels. Some Reits will invest specifically in one area of property – shopping centres, for example – or in one specific region or country.
Most UK Reits have a local focus, though a few have European investments. This sort of specialisation is a global characteristic of Reits, and reflects the diversity of legislation in some countries.
The major UK Reits are also many times larger than most property unit trusts, and are very transparent, as they are subject to continual scrutiny by the stockmarket.
“There’s a lot of money coming from overseas into the UK, whether it be in prime office buildings or residential, so UK property still seems to be quite popular in spite of the general economic environment. But then if that’s already priced into the portfolios of the property companies, effectively you’re already buying into that relatively good market,” says Mr Nicklin.
In the past three years to February 24 2012, Reits have outperformed the IMA Property sector, returning, on average, 77.15 per cent, compared with 60.83 per cent for the sector, according to Morningstar. The highest performing Reit, Derwent London, actually returned more than four times that, producing a return of 282.44 per cent.
In the five years to February 24 2012, all Reits posted a loss, with the average loss being 57.01 per cent, compared with funds in the IMA Property sector, which made an average loss of 26.36 per cent in the same time period. The worst performing Reit, Warner Estate Holdings, lost 99.58 per cent, according to Morningstar.
The disadvantage of a Reit, however, is that shares in listed property companies are significantly more volatile than direct property investments or unit trusts, and perform more like equities than property. Longer-term performance has been much poorer than for direct property, and shares in Reits have also continued to trade at a discount to the net asset value (NAV) of their investments. Nevertheless, over the long term, their performance is more closely correlated with property than equities.
Steve Buller, portfolio manager on the Fidelity Global Property fund, which invests mainly in Reits, admits discounts and premiums can be variable.
“In terms of valuations, on average property stocks overall are trading at a 15 per cent discount to estimated net asset values overall, with those in Hong Kong, Singapore and continental Europe trading at the greatest discounts and the US and Canada trading at a premium.”
Furthermore, Mr Buller argues that property stocks’ dependence on the availability of capital has made them vulnerable to the upheaval in financial markets. However, while real estate companies in Europe have face more restricted availability of capital, publicly listed property businesses in countries such as the US, Canada and Japan have been able to access capital more easily, and Mr Buller says this should continue into 2012, barring some unprecedented event in Europe and policy-related restrictions in China and Hong Kong.
Overall, Mr Buller says NAVs are expected to remain flat as price rises will be limited. “Overall the cost of capital is decreasing. There is predominately acquisition activity in the US and Canada but less in the UK, continental European and Japan. Other countries are not experiencing major change,” he says.
With property prices flatlining after significant declines in many areas, it appears that there could be a latent opportunities for price rises to come through in years to come.
“In a low growth, low interest rate environment, the sector’s dividend opportunities and yield from buildings make for an attractive investment,” says Mr Buller.
“The greater transparency of listed companies and exposure to ‘real’ assets compared to other financials give them an edge in uncertain times. There is considerable capital waiting on the sidelines to invest in this asset class and in direct property.”
Simona Stankovska is features writer at Investment Adviser
