Bricks and mortar investment

Commercial property funds have certainly gained traction with investors allocating billions of pounds into these over the last year.

Much of this has been driven by the emergency interest rate environment, which has pushed income investors into higher risk assets over the years. Bonds and then equity markets were the initial beneficiaries but such has been the demand for income, that yields in these areas have compressed.

Now that there is increasing speculation over rising interest rates, investors have been reducing their bond exposure in favour of property. In addition, recent stockmarket volatility has seen investors become scared of committing more money to equities and the focus has returned to lower risk assets with many viewing commercial property as a safer haven.

Commercial property funds are proving extremely useful for two main reasons: they are generating an income that is relatively attractive versus other asset classes; they are displaying a distinct lack of correlation with equity and bond markets.

In reality, investing directly in a portfolio of office blocks, factories and shops is unrealistic for most private investors and exposure to this area is best achieved through pooled collective investment funds, such as unit trusts, Oeics and/or investment trusts.

However, there are different ways to invest in property, the most common ways are:

• To invest in a ‘bricks and mortar’ property fund

• Invest in property shares

• Invest in a real estate investment trust

The latter two can provide an attractive level of income currently but as you are, in effect, buying shares in property companies, they are more correlated to economic and market sentiment. As such, they are subject to the vagaries of the stockmarket and the inherent risk this brings.

Therefore, to adequately gain the two desirable attributes of an attractive income and diversification, the best approach is to invest in ‘bricks and mortar’ property funds.

The majority of property funds are unit trusts. However, some property funds have converted into a Property Authorised Investment Fund.

A PAIF is an Oeic that can provide favourable tax treatment for investors. PAIF rules were introduced in April 2008 by HMRC as a way of enabling investors to receive income gross, rather than net of tax.

Within a property unit trust income is derived from several sources, including rental income and interest. Normally, all income distributed to investors from the fund is treated as a dividend distribution, which is paid with a non-reclaimable tax credit.

In contrast, although a PAIF will make one aggregated income payment also, it is required to divide income in to three separate parts for UK tax purposes – property income (mainly rental income), interest income, and other income from the PAIF usually treated as dividends.

Identifying each separate part of income allows each to be treated differently for tax purposes, with both property and interest income to be paid gross. This is particularly beneficial for Isa and pension investors.