The appeal of buying property via a listed fund was highlighted last summer when many open-ended UK property funds suspended trading for months at a time. This was done in order to stem a wave of redemptions triggered by a post-EU referendum panic, and left thousands of investors with no way of accessing their money. While you are not guaranteed to get a good price if selling out of a listed property fund, at least you have the option of getting out.
Investors looking to buy into property via listed funds have two main choices. The vast majority (over 80%) of listed UK property funds are structured as real estate investment trusts (Reits). A Reit invests in income-producing real estate, such as office buildings or shopping centres. They enjoy a special tax status, under which they pay no corporation tax on qualifying rental income and capital gains, but are obliged to pay out at least 90% of their income to shareholders. This means the double taxation (corporation tax and the tax on dividends) that is associated with ordinary property funds is removed.
Reits pay dividends as “property income distribution” (PID), which is paid after deduction of withholding tax at a rate of 20%. If you’re a basic-rate taxpayer, that takes care of your tax liability, while higher-rate and top-rate taxpayers will owe further tax. This can be avoided if the Reit is held within an individual savings account (Isa) or a self-invested personal pension (Sipp), when your stockbroker should either pay the PID gross of tax or reclaim it subsequently.
An alternative structure for property investment is the property investment company. Like Reits, these invest in real estate, but unlike Reits they are treated like any other company for tax purposes (and hence pay corporation tax on profits). Dividends paid by these companies are taxed at the usual income dividend tax rates (7.5% for basic-rate taxpayers on any dividends over £5,000. 32.5% for higher-tax taxpayers and 38.1% for additional-rate taxpayers).
Most UK property companies have converted into Reits since the Reit structure was first introduced to Britain in 2007. However, a few that prefer not to have to pay out the majority of their income as dividends and would rather retain it for other purposes – for example, reinvestment in new projects – have not converted.
Lastly, there are some UK-listed property investment companies that are incorporated abroad in destinations such as the Channel Islands or the Cayman Islands, where tax rules are more favourable and they don’t pay UK corporation tax on their income.
This is a relatively common structure for UK-listed funds that invest in real estate in more exotic locations that don’t have a Reit-like tax structure, such as many emerging markets. Whether a listed property vehicle is structured as a Reit, a UK company, or an overseas company is unlikely to be something that most investors directly take into account. However, in practical terms, most Reits are geared towards delivering a steady income and their portfolios tend to be made up of established assets. This makes them more appealing to investors looking for a reliable income stream.
By contrast, other property companies are sometimes more speculative, often involving early-stage developments, and therefore can be more risky. A cost effective way of investing in a range of property funds is via an exchange-traded fund. iShares FTSE EPRA/NAREIT UK Property ETF (LSE: IUKP) invests in a range of UK Reits, though has a bias towards London commercial property, and has a total expense ratio of 0.4%.