25 February 2021/ sale_commercial_property_guide

Everything you need to know about REITs

Always wanted to invest in the world of real estate, but don’t want the hassle that comes with it? A Real Estate Investment Trust (REIT) could be the ideal solution. You’ll get to enjoy the historically steady returns that real estate could potentially generate without the drawn-out purchase process and ongoing upkeep. Here’s everything you need to know about REITs.

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What is a REIT?

A REIT is an alternative way to invest in real estate without actually purchasing a property. Essentially, a REIT is a company that buys real estate with a pool of investors’ money, which could be domestic, commercial or a mixture of the two. It’s based on the mutual funds model, which uses a collective pool of investors’ money to invest in stocks, bonds and other assets or securities.

REITs have been around since 1960 in the US and they were hailed as an accessible way for everyday Americans to invest in property. After refining the model in the Tax Reform Act of 1986, modern REITs were born. The investment model arrived in the UK in 2007 after a number of key property investment companies converted their business models, and there are now lots of options for domestic investors.

How does a REIT work?

Investing in a REIT is a lot like purchasing stocks in any other company. The main difference is that REITs specialise in purchasing and managing real estate. There are three key types:

  • Equity REITs – Owns and operates real estate that produces income
  • Mortgage REITs – Lends money to real estate owners and operators, either through mortgages/loans or by acquiring mortgage-backed securities
  • Hybrid REITs – A combination of the two

You can buy into a REIT through a range of investment platforms and sell on your stake whenever you like, as REITs are traded on major stock exchanges including the London Stock Exchange. UK-based REITs have to share at least 90% of their taxable income with shareholders and will usually share as much as they can to make sure their business remains tax-efficient.

Why are REITs an attractive investment?

Historically, property investment has been a luxury only the wealthy could afford. Currently, the average residential property in the UK costs in excess of £249,000 and commercial properties regularly command seven-figure sums. Many people struggle to save enough for a deposit on their family home, let alone find enough money to purchase an investment property.

But with REITs, it’s possible to grab a slice of the property market with just a few hundred pounds and enjoy a return on your investment. You can invest across a number of property classes without needing any specific knowledge about each market.

What’s the difference between REITs and Real Estate Funds?

A similar way to pool your money and invest in property is a Real Estate Fund. The key distinction between the two is that a REIT is a company, which purchases and leases or funds property and pays its investors dividends of its profits.

A Real Estate Fund, on the other hand, is an investment vehicle that invests a collective pool of money into REITs, other real estate companies or directly in properties. They’re better for long-term investment as income tends to come from property value appreciation rather than ongoing dividends.

Pros of investing in a REIT

There are a number of benefits to investing in a REIT. Here are six of the key plus points:

  • REITs are currently exempt from corporation tax in the UK, so it’s a more tax-efficient way to invest in property if you’re looking to maximise how much profit you keep.
  • If you don’t like the sound of tying your money up in a potentially illiquid property, a REIT is a good option. It’s traded in the same way as stocks on the London Stock Exchange, so you can free up your money quickly if you need to.
  • You won’t have to worry about the day-to-day management of your property, including resolving tenant issues and keeping up with maintenance.
  • You can invest in property for less, as the minimum investment for REITs is typically far lower than the price of purchasing a property outright, or even the cost of a deposit.
  • When purchasing a property, in addition to your deposit you also have to cover legal expenses, stamp duty and other costs, which are eliminated with a REIT.
  • You’ll have access to higher value property classes, such as retail and leisure, that are usually reserved for high-net-worth property investors.

Cons of investing in a REIT

Though a REIT sounds enticing, there are drawbacks to this method of investment.

  • Unlike owning a property outright, the returns you get from investing in a REIT could potentially be smaller. That’s because, depending on how much you choose to invest, you may receive very modest dividends, particularly if the property market isn't very strong.
  • If a property appreciates in value, you may not enjoy any of the profits. Some crowdfunding REITs do share sale profits with investors, but they will be smaller than if you owned the whole property.
  • If your chosen REIT invests in a broad range of property types, the value of your investment could be dragged down if one class dips in value.
  • Many people who are attracted to property investment are keen to purchase an asset that can be passed down to their children or be sold to fund retirement. With a REIT, you won’t have a tangible asset.

Crowdfunding properties with a REIT

Another form of REIT is a property crowdfunding service. Though a relatively new option, crowdfunding allows investors to purchase a share of single property. You’ll enjoy a share of both the ongoing rental income and the potential profits when the property is sold on, usually after around five years.

Crowdfunding is another way to get your foot in the door of property investing, as some investment platforms will accept people who are not accredited investors (broadly defined as those with a net worth over $1 million). It’s popular with people seeking to diversify their portfolio internationally, as you can choose to own stake in a property in some of the world’s most buoyant property markets.

As with any kind of investment, there’s no guarantee you’ll enjoy returns from a crowdfunded property. It may also be a bit limiting if you’re only investing in one property, as your money won’t be cushioned should a particular sector dive in value.

Want to find out more about investing in property? Check out our investor guides for plenty of other bits of insight and guidance.