How To Invest In Real Estate Investment Trusts (REITs) (2024)

There are several reasons one would consider investing in property. First, there’s the chance of benefiting from capital growth in the shape of rising property prices.

Landlords also have the opportunity to secure a reliable income stream in the form of rental payments.

But investing in property also has its downsides. As with any form of investment, property comes with no guarantees. The market ebbs and flows, often according to economic conditions, and investors cannot expect the value of a particular building to rise inexorably.

In addition, not everyone can afford to buy a property for investment purposes. Even if they can, property tends to be an ‘illiquid’ asset, meaning it can be difficult to sell a building quickly at a fair price.

Why invest in property?

There are several reasons why it’s generally worth thinking about investing in property:

• Capital growth: as property prices rise, so the return increases on an initial investment. Should prices fall, however, an investor would lose money if they had to sell when the value of the property was ‘under water’, that is, worth less than the original price.

• Rental income: a tenant paying rent on a property provides would-be landlords with a steady income stream often secured for long periods (potentially several years at a time).

• Diversification: property tends not to perform in line with other assets such as bonds or stocks and shares. It is said to be ‘non-correlated’ and can therefore complement the performance of an existing basket of assets.

What sort of property?

Some property investors, such as ‘buy-to-let’ investors, favour investing in residential property, such as student flats. Read more about the buy-to-let market here.

Commercial property, on the other hand, offers would-be investors exposure to a different part of the bricks and mortar landscape.

There are three main types of commercial property:

• Industrial: business parks, industrial estates, factories and warehouses

• Office: such as blocks leased out to businesses

• Retail/leisure: shopping centres, high street premises, entertainment and holiday parks.

Although they are able to generate large amounts in rental income, commercial properties such as those outlined above are often far more expensive than residential buildings to buy outright, usually costing millions of pounds.

As such, direct exposure to this sector through purchase is beyond the pockets of most private investors, so the main option is to buy into commercial property funds.

Types of commercial property fund

There are two main types of commercial property investment vehicle: direct and indirect funds.

Direct property funds are run by professional investment management firms where money is pooled from potentially thousands of investors in order to buy a range of different buildings.

Doing this helps provide diversification. It means that if one or more properties within a portfolio are unoccupied for a period of time, the others are still able to provide a rental income for the fund.

Indirect property funds invest in the shares of firms that operate in the property and property development sector. Their performance, therefore, tends to be more closely connected to the wider market for stocks and shares.

For flexibility, there are also funds that employ a hybrid approach that enable investors to invest in both direct property and in property-related securities.

How are property funds structured?

Property funds are either ‘closed-ended’, such as real estate investment trusts or REITs (see below), or as ‘open-ended’ investment funds including unit trusts or open-ended investment companies (OEICs).

An OEIC is incorporated as a company and issues shares. Unit trusts represent a pooled sum of money that’s been structured as a trust and which issues units to investors.

The financial value of the units or shares in a unit trust or OEIC increases or decreases based on the value of the assets which underpin the funds.

How do REITs work?

Closed-ended funds such as REITs are stock market listed and trade like traditional stocks and shares, meaning they can be traded throughout the day and making them a relatively liquid asset. Property itself will be viewed as ‘illiquid’ if it is difficult to sell quickly at a fair price.

When investors want to sell large amounts of their holdings in open-ended property funds, it’s sometimes the case that buildings owned by the fund have to be sold to generate the necessary cash.

It’s this characteristic that has made open-ended property funds something of a concern for the UK financial watchdog, the Financial Conduct Authority, in recent years.

This is because the illiquid nature of buying and selling large buildings means investors can be locked into a fund while they wait for managers to sell off one or more buildings. This process can take months, or even years, leaving investors unable to access their cash.

In contrast, closed-ended funds issue a set number of shares, so once these are all in circulation, investors can trade them on the market as they would any other stock.

REITs in close-up

Real estate investment trusts were launched in the US in the 1960s but were only introduced into the UK in 2007. They look to own, operate, or finance income-generating property assets, enabling would-be investors to have exposure to a group of properties through a single investment.

A REIT is a type of investment trust that is listed like a company on a stock exchange, such as the London or New York Stock Exchange. But instead of investing in securities such as bonds or equities, REITs aim to make money for their investors through property transactions.

You can read more about investment trusts here.

As with all investment trusts, REITs can trade at a discount or a premium to their net asset value (NAV). The NAV is widely regarded as a key metric when it comes to analysing REITs. You can read more about NAVs here.

Types of REIT

REITs often specialise in a particular area of the property market including:

• Apartments

• Office blocks

• Shopping centres

• Hotels

• Healthcare facilities

• Self-storage facilities

• Data centres.

In the UK, a REIT must own commercial or residential and rent it out. At least three-quarters of its profits must come from rental income.

In addition, a REIT must also distribute at least 90% of the profits it makes from this business to shareholders. The companies that qualify as REITs pay no corporation tax on either profits or gains from their UK-qualified property rental businesses.

Instead, shareholders pay income tax on the distributions they receive. These are technically known as ‘property income distributions’, but they do not count as dividends in the same way as payouts do from other listed companies.

This makes REITs a potentially tax-efficient way to invest in property. First, they leave retail investors free to use their dividend tax allowance – the amount from dividends an investor is allowed to earn tax-free each year – on other investments.

Despite protests from the investment industry, this allowance was recently reduced so that the figure now stands at £1,000 for the 2023-24 tax year. Note that the current plan is for this figure to be halved again at the start of the next tax year in April 2024.

In addition, if you hold REIT shares in an individual savings account (ISA) or private pension such as a self-invested plan, both of which shelter investments from tax, there will be no income tax to pay on the distributions you receive.

UK’s largest REITs

REITs are broadly regarded as the backbone of the listed property sector.

They fall into two main categories. The first comprises businesses that could be described as property trading companies – most listed property companies, including the property developers British Land (BLND) and Land Securities (LAND), opted for REIT status once the regime was introduced in the UK.

Other REITs are in effect collective investment vehicles, operating in a similar way to an investment trust, but with a focus on the property market rather than overseeing a large basket of stocks and shares from a variety of sectors.

The UK’s largest REITs are worth billions of pounds as measured by their market capitalisation (see Table 1 below). Market cap is calculated by multiplying the number of shares in circulation by the share price.

REITs are relatively easy to buy and sell via online trading platforms and investment apps.

UK REITs, market capitalisation in excess of £1 billion

REITs can be specialist in nature and do not necessarily offer broad property exposure in the style of more traditional property unit trusts and OEICs. Interest in REITs will also ebb and flow subject to the bricks and mortar requirements of the day.

For example, interest in retail outlets waned significantly during pandemic lockdowns and at the height, while the need for warehouse space has risen on the back of the e-commerce boom.

Should I invest in REITs?

The London Stock Exchange describes REITs as a “way for investors to access the risks and rewards of holding property assets without having to buy the property directly”.

To this end, an investor with existing exposure to shares, bonds and cash looking for extra diversification could consider property in general and REITs in particular as a means of achieving this.

It’s worth remembering, though, that REITs come in a variety of shapes and sizes each with their own risk and reward characteristics.

On the one hand, British Land, Landsec, and AEW UK Reit (AEWU) could be regarded as generalist players because they don’t focus on one kind of property, preferring to spread their interest across several areas.

Investing in a specialist REIT means restricting yourself to a particular niche within the property sector.

For example, you might think there is potential in the warehouse market, and there are several REITS which satisfy this need. For example, Tritax Big Box (BBOX) owns large warehouses let out on long leases to international companies in regional areas.

The company says it “seeks to exploit the significant opportunity provided by the imbalance between strong occupational demand and constrained supply of modern logistics real estate in the UK”.

On the other hand, Urban Logistics (SHED) owns smaller warehouses, usually on the edge of city centres, and typically located in “established logistics regions” such as the Midlands’ ‘golden triangle’ – bounded by Nottingham, Birmingham and Northampton.

Meanwhile, Industrial REIT (MLI) owns even smaller units that tend to be let out on short leases to small businesses.

Investors who pick a property sector on an upwards curve will likely benefit from booming demand, soaring property values and competitive rental income. Choose unwisely, however, and the reverse is true.