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There are several reasons to consider investing in real estate. First, you may benefit from increased capital in the form of rising property prices.
Landlords also have the opportunity to secure a reliable source of income in the form of rent payments.
However, real estate investment also has disadvantages. Like other forms of investment, real estate comes with no guarantees. Investors can't expect the value of a particular building to rise relentlessly, as the market waxes and wanes depending on economic conditions.
Moreover, not everyone can buy real estate for investment purposes. Even if you can sell, real estate tends to be an “illiquid” asset and it may be difficult to sell the building quickly for a fair price.
Investing in real estate is appealing, but if becoming a landlord seems like a hassle or you can't repay your mortgage even after accumulating a down payment, you may have the option of considering a real estate fund such as a real estate investment trust (REIT). there is.
REITs have been a hot topic this year following the announcement of a merger between two of the UK's largest companies. (Please refer to the following).
Let's take a closer look at REITs and how they work, and explain why it's worth investing in real estate.
Tax treatment depends on individual circumstances and may change in the future. The content of this article is provided for informational purposes only and is not intended to be, and does not constitute, tax advice.
Accurate at the time of publication.
Why invest in real estate?
There are several reasons why investing in real estate is generally worth considering.
- capital growth: As real estate prices rise, the return on the initial investment increases. However, if prices fall, investors will lose money if they have to sell the property when it is worth “below water,” meaning it is worth less than its original price.
- rental income: A tenant who pays rent on a property provides a stable source of income for a prospective landlord, often secured for a long period of time (sometimes years at a time).
- Diversification: Real estate tends not to perform as well as other assets such as bonds and stocks. It is said to be “uncorrelated” and therefore can complement the performance of an existing basket of assets.
What kind of property is it?
Some real estate investors, such as “buy-and-sell” investors, prefer to invest in residential properties such as student apartments. Click here to learn more about the buying and selling market.
Commercial real estate, on the other hand, offers prospective investors exposure to different parts of the brick-and-mortar landscape.
There are three main types of commercial real estate.
- Industrial: business parks, industrial parks, factories, warehouses
- Office: Areas rented out to companies, etc.
- Retail/Leisure: Shopping centres, high street facilities, entertainment and holiday parks.
Although these can generate significant rental income, commercial properties such as those outlined above are often much more expensive than buy-out residential buildings, typically costing millions of pounds. .
Direct exposure to this sector through purchase is therefore beyond the pockets of most retail investors, and the main option is to buy commercial real estate funds.
Types of commercial real estate funds
There are two main types of commercial real estate investment vehicles: direct funds and indirect funds.
Direct property funds are managed by professional investment management companies and pool money from potentially thousands of investors to purchase a variety of buildings.
This way you can diversify. This means that even if one or more properties in the portfolio are vacant for a period of time, other properties can continue to provide rental income to the fund.
Indirect real estate funds invest in shares of companies operating in the real estate and property development sector. Therefore, their performance tends to be more closely tied to the broader market for stocks and share certificates.
For greater flexibility, some funds take a hybrid approach, allowing investors to invest directly in both real estate and real estate-related securities.
How is a real estate fund structured?
Real estate funds can be “closed-end” investment funds, such as real estate investment trusts or REITs (see below), or “open-end” investment funds, such as unit trusts or open-end investment companies (OEICs).
OEIC is established as a company and issues shares. A unit trust represents a pooled amount of money that is structured as a trust and issues units to investors.
The financial value of units or shares in a unit trust or OEIC increases or decreases based on the value of the assets backing the fund.
How do REITs work?
Closed-end funds, such as REITs, are listed on stock markets and trade like traditional stocks and shares, making them a relatively liquid asset that can be traded throughout the day. The property itself is considered “illiquid” if it is difficult to sell quickly for a fair price.
If an investor wishes to sell a significant amount of an open-end real estate fund's holdings, it may be necessary to sell buildings owned by the fund to generate the necessary cash.
It is this characteristic that has made open-end property funds a cause of concern for the UK's financial watchdog, the Financial Conduct Authority, in recent years.
This is because the buying and selling of large buildings is illiquid and investors can become trapped in the fund while waiting for the administrator to sell one or more buildings. . This process can take months or even years and leaves investors without access to their cash.
In contrast, closed-end funds issue a set number of shares, so once these are all in circulation, investors can trade them in the market like any other stock.
REIT close-up
Real estate investment trusts were established in the US in the 1960s, but were only introduced to the UK in 2007. Real estate investment trusts seek to own, operate, or finance income-producing real estate assets, allowing would-be investors to have exposure to a range of real estate properties. With just one investment.
A REIT is a type of investment trust that is listed like a company on a stock exchange such as the London Stock Exchange or the New York Stock Exchange. However, rather than investing in securities such as bonds or stocks, REITs aim to generate profits for investors through real estate transactions.
Click here for more information about investment trusts.
Like all mutual funds, REITs can trade at a discount or premium to their net asset value (NAV). NAV is widely recognized as an important metric when analyzing REITs. Learn more about NAV here.
Types of REITs
REITs often specialize in specific areas of the real estate market, such as:
In the UK, a REIT must own commercial or residential property and rent it out. At least three-quarters of the profit must come from rental income.
Additionally, the REIT must distribute at least 90% of the profits from this business to shareholders. Companies that qualify as REITs do not pay corporation tax on the profits they derive from qualified property rental operations in the UK.
Instead, shareholders pay income tax on the distributions they receive. Although these are technically known as “property income distributions,” they do not count as dividends in the same way as payments from other publicly traded companies.
Because of this, REITs can be a tax-efficient way to invest in real estate. First, it would allow individual investors to freely use the dividend tax credit (dividends that investors can receive tax-free each year) for other investments.
Despite protests from the investment industry, the allowance was recently reduced to £1,000 for the 2023-24 tax year. Note that under the current plan, this figure is scheduled to be halved again in April 2024, which is the start of the next tax year.
Additionally, if you hold REIT shares in a private pension such as an Individual Savings Account (ISA) or self-investment plan, you won't have to pay income tax on the distributions you receive, as both protect your investments from tax. there is no.
UK's largest REIT
REITs are widely considered to be the backbone of the publicly traded real estate sector.
They fall into two main categories. The first is comprised of businesses that can be described as real estate trading companies, and most listed real estate companies, including real estate development companies British Land (BLND) and Land Securities (LAND), will be in the market once the REIT system is introduced in the UK. Selected REIT status.
Other REITs are effectively collective investment vehicles, operating in a similar way to mutual funds, but rather than overseeing large baskets of stocks or shares in various sectors, they focus on the real estate market. I am.
The UK's largest REITs are worth billions of pounds as measured by market capitalization (see Table 1 below). Market capitalization is calculated by multiplying the number of shares outstanding by the stock price.
REITs are relatively easy to buy and sell through online trading platforms and investment apps.
UK REIT's market capitalization exceeds £1 billion
REITs can be specialized in nature and do not necessarily provide broad real estate exposure in the style of a traditional real estate unit trust or OEIC. Interest in REITs also waxes and wanes depending on the brick-and-mortar requirements of the day.
For example, during and at the height of the pandemic lockdown, interest in retail stores waned significantly, while the e-commerce boom has increased the need for warehouse space.
Should you invest in REITs?
The London Stock Exchange describes REITs as “a way for investors to access the risks and rewards of owning real estate assets without having to buy the property directly.”
To this end, investors with existing exposure to stocks, bonds, and cash seeking additional diversification may consider real estate in general, and REITs in particular, as a means to achieve this.
However, it's worth remembering that REITs come in many shapes and sizes, each with their own risk and reward characteristics.
On the other hand, British Land, Landsec and AEW UK REIT (AEWU) can be considered generalist players as they do not focus on one type of real estate, preferring to spread their interests across multiple sectors.
Investing in a specialized REIT means you are limited to a specific niche within the real estate sector.
For example, you may think there is potential in the warehouse market, and there are several REITS that meet this need. For example, Tritax Big Box (BBOX) owns a large warehouse that it has long-term leases to local international companies.
The company says it is “looking to capitalize on the significant opportunity presented by the imbalance between strong job demand and constrained supply of modern logistics real estate in the UK”.
In February 2024, Tritax Big Box discussed a potential merger with smaller rival UK Commercial Properties to create the UK's fourth largest listed landlord with a property portfolio of approximately £6.3bn. Agreed.
The news followed warehouse owner London Metric's announcement a month ago that it would acquire LXI, a landlord focused on real estate income.
Commenting on the move, John Moore, senior investment manager at RBC Brewin Dolphin, said: “With the LXi transaction, London Metric is challenging the 'old-guards' of the UK property industry, namely Land Securities and British Land. We are positioned to be a leading real estate company that can benefit from the changes the real estate industry is currently experiencing.”
On a different note, Urban Logistics (SHED) owns small warehouses, usually on the edge of city centres, such as in the Midlands 'Golden Triangle' between Nottingham, Birmingham and Northampton. Located in an “established logistics region”.
Industrial REITs (MLIs), on the other hand, own even smaller units that tend to be rented out on short-term leases to smaller businesses.
Investors who choose real estate sectors on the upswing can benefit from strong demand, rising property values, and competitive rental income. However, the opposite is also true if you don't choose wisely.
