Is this the Reit way to go?

By MICHAEL CLARKE
Updated: 11:20 EST, 19 December 2005

Gordon Brown slammed one door shut in his Pre-Budget Report by scrapping the planned move to allow Self Invested Personal Pensions to invest in residential property.

But the Chancellor, who was widely criticised for the Sipps u-turn, has opened another door with Real Estate Investment Trusts (Reits) – tax-efficient vehicles for property investment.

Reits will allow retail investors to invest in property without the risks or complications of direct ownership. Investors will be able to gain access to the Reits, expected to come into force in January 2007, either through buying shares in a Reits structure or a fund that invests in Reits.

To make them even more tax friendly, draft legislation laid before parliament yesterday said that people will be able to hold Reits in Isas.

Brown's view is that a Reit is a more appropriate property investment vehicle for individual pensions than buying a single property as it reduces the risks involved.

Under the proposed Reits structure, property companies would pay no corporation tax but would hand 95% of net profits back to investors. The Reits would withhold the basic rate of tax of 22% on their distributions to shareholders and higher rate taxpayers would have to fund any outstanding payments.

In addition, under trust status the Treasury would lose substantial Capital Gains Tax and other corporate taxes. Therefore, not only do investors avoid all of the tax issues involved with owning a property directly, they will also receive larger dividends from the Reit than they would from holding a normal stock.

Tom McPhail, head of pensions at Hargreaves Lansdown, says: 'It's been comical watching the Chancellor over this issue, but ultimately it's probably the right way to invest in property.

'We still need some issues cleared up, such as how the tax status will work with people that are investing in Reits through their pensions, but it's a step in the right direction.'

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Most property companies are expected to revert to Reit status, while some of the firms that have delisted in recent years will return to the stock market. It is thought the size of the listed property sector could triple as a result of the change.

Brown hopes that the UK vehicle will mirror the success Reits have enjoyed throughout the world. The global Reit market is worth around $600bn and is expected to grow to $1 trillion by the end of the decade as investors are attracted to their high yields and steady incomes.

Under the proposed legislation, the Government has taken steps to make sure Reits don't over-burden themselves with debts or new developments. Three quarters of Reit's income would have to be from property rents, with the remainder from developments and other services.

They will also be subject to 'asset tests' from HM Revenue & Customers to ensure they don't carry out too much development as a proportion of their activities. An 'interest cover test' will also be imposed to make sure they aren't borrowing beyond their means.

The ratio will be worked out by taking profits plus financing costs and dividing that by financing costs. This figure must be above 2.5, which, it is believed, will restrict participation in risky developments and non-core activities.

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In addition, to limit the influence of one single shareholder, the legislation proposes that no one shareholder will be allowed to own more than 10% of a Reit.

However, there are still question marks over their introduction. The Investment Management Association welcomes Reits but, as they need to be listed vehicles, questions whether they can be converted before the proposed launch.

Daniel Godfrey, Director General, Association of Investment Trust Companies added: 'The condition that no person controls 10% or more of the share capital or voting rights of a REIT in particular sounds unworkable for a listed company operating in a free market and we find it difficult to see how this could be imposed.'

And as the Government will lose a large chunk of cash from the tax changes, firms considering converting to Reit status are also wary of the charge for doing so.

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