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Reit petite

Sonia Speedy looks at the prospects for real estate investment trusts and finds that building critical mass could prove difficult

Real estate investment trusts still face several hurdles in the UK but many firms are already making plans to move into the sector.

Reits were introduced in the US in the 1960s and publicly traded US Reits now control assets of nearly 200bn. Many other countries have Reit legislation, such as Australia, France, Japan, the Netherlands and Belgium.

In the UK, it is proposed that Reit companies could invest in any kind of property, in any location and get full tax relief on capital gains and rental income as long as a high proportion, probably 95 per cent, of the returns are distributed to investors.

It is likely that at least 75 per cent of gross income will have to come from property rents and at least 75 per cent of gross assets invested in properties that are generating rental income.

Royal Institute of Chartered Surveyors economist Oliver Gilmartin says the UK is the last G7 nation to install such a vehicle. RICS says Reits will offer an alternative to investing in commercial or residential property.

He believes the success of Reits will be a matter of timing. With residential property offering lower yields than commercial, landlords have been looking to capital appreciation but with residential slowing down, this is more difficult. “If that slows, then the interest as a retail investor for a residential Reit may start to wane slightly,” he says.

Savills head of residential research Richard Donnell says residential Reits are unlikely to invest in what is traditionally thought of as residential property but will go for the likes of student housing or buying a block of flats, putting in place a commercial lease structure and letting it to a housing association. Leasing to an employer of key workers is another option to help avoid tenant management headaches but he cautions there is not a lot of that stock around.

He says: “I do not know what the view is on how big a Reit needs to be to achieve a critical mass but if you want to spend 500m on residential assets tomorrow or in the next year you would have a bit of trouble on your hands. That is the big challenge with residential, it is finding the stock and getting the right sort of income-return profile.”

Donnell believes initially, funds will be largely commercial and that indirect property investment will be a big growth area but with a lot of residential funds being put together to target the changing Sipp legislation.

He says: “I think we are going to see quite a few people put together residential property funds where you can buy units or shares but they are not necessarily going to be in Reit structures. They are going to be in offshore listed vehicles.” Donnell believes indirect property investment funds are a first step towards Reits and the market will need to grow these smaller funds towards creating Reits which need scale.

Director of Grant Thornton’s London property team Marion Cane also believes residential Reits will be slower to take off than commercial. She outlines the vital issues still to be decided for Reits as how non-residential investors will be taxed, the level and measure of gearing and whether or not the regime will be restricted to listed firms.

Cane says there were fears when the consultation star- ted that Reits would be highly regulated with very strict rules on issues such as gearing and management. “But they seem to have backed down on some of those areas, and what is being proposed now, as far as we know, is welcome,” he adds.

Both Cane and Gilmartin agree that success for Reits hinges on getting the conversion charge right. Cane says that, without existing property companies coming on board, the new regime will struggle to achieve critical mass.

Gilmartin says: “If there is a change in tax transparency, then that would entice money from offshore to come back onshore. If the conversion charges of bringing that money back onshore are too high, then that might outweigh the benefits that people see in managing all their assets from the UK.”

F&C Property Asset Management managing director Paul Herrington says it is hard to know how the introduction of a UK Reit will affect the market with the legislation still unclear.

F&C already has three property trusts offshore investing in UK commercial properties, which Herrington says have been attractive due to their high income return.

“With what we have done with our offshore vehicle, there is no real reason for us to alter dramatically what is currently done. A lot of it would depend on the conversion charge or getting the assets into these vehicles,” says Herrington.

BestInvest business development manager Justin Modray welcomes the fund choice and opportunities that Reits would give smaller investors but he warns the biggest risk is investors becoming overweight in property, particularly with high property prices in the South.


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