Investing in Property

Direct investment in property, for example via buy-to-let, is out of reach for many retail clients. Being able to afford to invest in a number of buy-to-let properties so as to create sufficient diversification is even less attainable. However, for those wishing to gain exposure to the property market, indirect investment methods can offer a diversified route at affordable contribution levels.  Some methods have the added advantage of tax efficiency. This article is particularly relevant to the CII R02 and AF4 exams but may also be useful for those studying R01, R03, R06, AF1, and AF5.

Shares in Listed Property Companies

An investor can buy shares in listed property companies that themselves hold diversified portfolios of properties.  In addition to the usual risks attached to holding shares, it is worth noting that property companies can be highly geared (i.e., they may borrow heavily) so that they can buy more property. This can make their share price more volatile than average. 

Collectives

Collective investments offer a less risky approach to the investor. Unit trusts, OEICs, investment trusts, and life offices all offer property funds giving good exposure to this particular market.

Many funds can be ISA- or pension-wrapped, meaning that income and gains within the funds are not subject to UK taxes potentially boosting performance. For ISAs, there will be no CGT payable on encashment and for pensions, up to 25% of the fund can typically be taken free from income tax, with the remaining 75% taxed as earned income under PAYE. 

Property Authorised Investment Funds (PAIFs)

Authorised investment funds that are mainly invested in property (known as property authorised investment funds or PAIFS) can apply for a tax treatment which means that rental profits and other property-related income are exempt from tax in the fund and the taxation instead moves to the investor.  Other taxable income is subject to corporation tax.

Distributions to investors are split into property income which is paid net of 20% income tax although non-taxpayers can claim this back, gross interest distributions, and dividends which are also paid gross.

In order to claim under this regime, at least 60% of the net income of the PAIF and 60% of total assets must be from the exempt property investment business.  The fund itself must be an OEIC, so unit trusts would have to convert to take advantage of the regime. 

Real Estate Investment Trusts (REITs)

Real estate investment trusts (REITs) own and manage property on behalf of shareholders.  They provide a way for investors to access property assets without having to buy property directly and yet they have a tax treatment that is closely aligned with the tax arrangements in place for direct investment.  They are effectively another type of collective investment which pools investors’ money.  A REIT can contain commercial and/or residential property.

In the UK, a company can apply for UK REIT status, which means they are exempt from corporation tax on profits and gains from their UK qualifying property rental business.  To qualify as a REIT, a company must be traded on a recognised exchange.

For tax purposes, a REIT has two separate elements: a ring-fenced property letting business which is exempt from corporation tax, and a non-ring-fenced business – for example, the provision of property management services; profits and gains here are subject to corporation tax.

Other conditions must also be met: the company must obtain at least 75% of its total gross profits from its tax-exempted property letting business; at the beginning of each accounting period, at least 75% of the total value of assets held by the UK REIT must be held in the tax-exempt property letting business; interest on borrowing has to be at least 125% covered by rental profits – in other words, they can’t have a lot of debt. (If the cover falls below this, they will be taxed on the excess interest).

For each accounting period, they must distribute at least 90% of the rental profits by way of a dividend (known as a property income dividend or PID).  The PID must be made 12 months from the end of each accounting period.

Property that has been developed for investment purposes will be CGT-free unless it is held for less than 3 years, in which case any gain will be subject to corporation tax.

For the investor, gains on a REIT are subject to CGT in the usual way.  Payments to investors from the ring-fenced element (the corporation tax-exempt element) are classed as UK property income and paid net of 20% tax (which nontaxpayers can reclaim).  ISA and SIPP investors can receive this gross.  Dividend payments from the non-ring fenced portion (the non-corporation tax-exempt element) are taxed as UK dividends.

In summary, buying shares in a REIT allows investors to invest in various types of property without the inconvenience of physically buying bricks and mortar.

Grab the resources you need!

If you’re studying for your CII R02 exam, and you’re wondering how you’ll ever manage to pass, grab our free taster to try out one of Brand Financial Training’s mock exam papers for yourself.  Click the link to download the R02 mock exam taster now!

Alternatively, you can download the taster for AF4 or J10 if either of those exams is causing you to worry.

Information in this article is correct as at 3 October 2022.