The best way to invest in property

Property has always been a very popular investment. Over the years, many people have shunned pensions, and stocks and shares individual savings accounts (Isas), for the comfort of owning bricks and mortar.

It’s not difficult to see why.

As well as providing you with somewhere to live, over the last 30 to 40 years, property has done very well. Its value has risen faster than wages, or the cost of living. It’s made many people rich.

Through rents, property is also seen as a good source of investment income, similar to the dividends from shares, or the interest from bonds. The phenomenal growth in buy-to-let landlords during the last decade is evidence of this.

The trouble is, you need a lot of money to buy a rental property. And banks are not as keen to lend money against property as they were a few years ago. There’s also the fact that a lot of property looks overpriced – there might be underpriced gems out there, but finding them is quite another thing.

The good news is that there is an easier, less expensive, and arguably less risky way for you to get an income from property. You can invest in real estate investment trusts – Reits for short.

What are Reits?

Reits (pronounced ‘reets’) are property companies listed on the stock exchange. They invest in rental properties. These can be commercial properties such as offices, warehouses or shops. Alternatively, they can invest in flats or apartments.

Reits were established in the UK in 2007 and offer investors a way to own property assets without buying them directly. Many of the UK’s largest landlords have since converted to Reit status.

The main reason for doing so is that they pay less tax to the government. All the rental profits and capital gains on rental properties are exempt from corporation tax.

However, there are strings attached: 90% of the rental profits must be paid out in dividends to shareholders each year, and any profits from property development are subject to normal rates of corporation tax.

Reits pay a special type of dividend. This is known as a property income distribution (PID). These are slightly different from the dividends paid on most ordinary shares.

With an ordinary dividend, a tax charge of 10% is withheld and paid to the government. So if you have received £90 in dividends from a company, the actual dividend paid by the company was £100 (£90/0.9); £10 has been paid to the government in tax. As a basic rate taxpayer, you do not have to pay any more tax on your £90.

PIDs are different. Here, 20% of the dividend is withheld and paid to the government. However, if you hold the shares of a Reit in an Isa or a Sipp, your broker can help you avoid this tax so that you receive all of the PID (100%). This usually involves filling in a form and informing the Reit of your tax status.

Some Reits also pay normal dividends on top of PIDs. The normal tax treatment will apply to this part of your dividend.

What’s good about Reits?

Reits can be a much better option than buying and renting a property out yourself. At the moment, for example, the dividends you can get from some Reits will give you a better return on your money than buying a house in your local area.

The most obvious benefit is that you don’t have to worry about collecting rents, finding tenants and doing repairs. The Reit does that for you.

But probably the best thing about Reits is that, unlike a buy-to-let property, you can buy and sell them quickly: you just trade them in the same way as an ordinary share. A few clicks of a mouse and you can dispose of your interest in your rental properties. There’s no need for estate agents or solicitors and the money and time they cost you.

Of course, it’s not all plain sailing. Depending on the state of the economy and the type of property being rented, rental incomes can go up and down a lot.

Also, expect the net asset value (NAV – assets less debt and other liabilities) to move around a lot too. This is because Reits will have to regularly revalue their properties.

What to look out for

There are currently 20 Reits listed on the London Stock Exchange, including FTSE 100 stocks such as British Land and Land Securities. But what should you look for if you are thinking of buying shares in a Reit?

The most obvious thing to look at is what the Reit actually owns. Are you buying the shares of a company that owns warehouses in the middle of nowhere? Or one that has top quality offices in central London? Or some of the country’s biggest shopping centres? The safety of the monthly rent cheque is likely to be much higher in properties that are rented out most of the time.

It will also pay you to look at the company’s balance sheet. Have a look at how much debt the Reit has and compare it with the value of its assets. It’s probably a good idea to avoid Reits that have too much debt, as a fall in rental income could mean a big reduction in your dividend payment.

Overall, Reits do away with many of the disadvantages of attempting to build your own buy-to-let portfolio. If you’re considering investing in property, they’re well worth considering as an alternative.