Investing in REITs

VIDEO: Ken Fisher – Is Real Estate a Good Investment?

2:39 minutes

Have you ever thought about investing in real estate? Do you know someone who has made a real estate investment work for them? While real estate can sometimes be a good investment, it usually isn’t quite as good as many people think.

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Especially when property values rise, many investors consider buying or otherwise investing in property. For many, directly investing in property—buying property or a share in a piece of property—is the most familiar way to do this. But the cost and complexity of direct property investments, especially outside of your local market, may make this asset class difficult for many investors.

Real estate investment trusts (REITs) offer a way for those who may lack the money, knowledge or time to directly invest in property to participate in this sector. But before investing it is important to carefully consider all aspects of REITs: how they work, how they are taxed and other considerations.

What are Real Estate Investment Trusts (REITs)?

REITs are a way of indirectly investing in property. REITs pool capital to purchase income-producing residential or commercial properties. REITs are an investment vehicle that allows individuals to access the risks and rewards of property ownership without having to buy property directly and then maintain and manage that property. They also enable shareholders to own interests in property types that are not easily accessible to most individuals. Some REITs specialise, for example, in healthcare, retail, industrial, or office properties, whilst others invest more broadly.   

In the UK, REITs are required to pay out 90% of their property income to shareholders every year, usually as dividends. REITs must be publicly listed and traded on a recognised stock exchange. REITs must derive most of their income from property rental as opposed to property development more broadly.

Whilst REITs have existed in the US since 1960, they were not launched in the UK until 2007. Since then REITs have grown substantially in number and size, with established property companies converting to REITs and start-ups also joining the field.

Investors find REITs an attractive asset class for a number of reasons. REITs can make it easier to invest in property and do so through a vehicle that is relatively liquid and low-cost. REIT fees are typically quite modest when compared to the large one-off transaction fees that arise when directly investing in property. By including multiple properties that may span different sectors (industrial, office, residential) and geographic regions, REITs typically offer greater diversification than directly owning properties. Like equities, UK REITs trade on exchanges, so many are fairly liquid and priced daily. With a REIT, unlike directly owning a property, there is no additional management or maintenance.

Tax and retirement planning considerations

REITs’ requirement to pay out 90% of their income to shareholders is known as Property Income Distribution (PID). PID is usually distributed as dividend payments. Dividend payments can be entirely PID, but they can also include non-PID income. PID and non-PID dividends are taxed differently.

PIDs are generally taxable as income from a property business and will appear as “other income” on UK tax returns. Normally PID dividends are subject to withholding tax at the basic rate of income tax (20%), which is then sent to Her Majesty's Revenue and Customs (HMRC). You can find more information on the gov.uk website.^[i]

Non-PID dividends are generally taxed as dividends. For 2018–2019 tax year, you only pay taxes on dividends if you exceed the dividend allowance of £2,000. If you exceed the dividend allowance, you are taxed based on which income tax band you are in. You can find more information on this topic on the gov.uk website.^[ii]  

REIT shares can also be held in Individual Savings Accounts (ISAs), Junior Individual Savings Accounts (ISAs) and Child Trust Funds (CTFs), which may have special tax advantages.

Other considerations

Since REITs often produce dividends—due to the requirements listed above—it may be tempting for some investors to concentrate a large portion of their portfolio in REITs. After all, a steady stream of dividend payments can seem attractive. Before making any such portfolio moves, consider they might affect your overall portfolio diversification. Heavily investing in REITs, directly or indirectly, can decrease the diversity of your portfolio, which may introduce greater risk. The more concentration you have in any part of the market, the more susceptible you are to factors that affect that part of the market. An investor heavily concentrated in REITs could see her portfolio fall in value, whilst a better-diversified equity investor may not suffer the same decline.

Also consider: whilst the steady income stream that dividend-bearing REITs offer may be attractive to investors who need portfolio withdrawals to sustain their spending, especially during retirement, relying heavily on REITs may leave you under-diversified. Also there may be other ways for you to generate cash flow to fund your retirement. For instance, even an investor who owns only non-dividend-paying equities can generate cash flow when he or she retires by selectively selling stock in a process we term “homegrown dividends.” Selectively selling equities for cash flow can help you maintain a well-diversified portfolio and meet your goals and objectives. 

If you are considering investing in REITs or would like help thinking about how much money you need and how you will fund your retirement, Fisher Investments UK can help you plan and weigh your investment options. Planning for your retirement can be complicated. We may be able to help you consider your unique situation, set long-term investment goals, and stay on the path to realise your retirement goals. Contact us today to learn more.

^[i] https://www.gov.uk/hmrc-internal-manuals/guidance-real-estate-investment-trusts/greit08005

^[ii] https://www.gov.uk/tax-on-dividends