03: Commercial property investment options

Direct investment in commercial property is generally not a practical option for the private investor. It takes substantial sums of money and resources to build and manage a reasonably diversified commercial property portfolio – the average value of property measured by IPD is over £9m.

The main options for the non-institutional investor are:

Property company shares

The UK stockmarket offers a wide choice of property companies, although the number has shrunk because of conversions to real estate investment trusts (REITs) take place. Property company shares are generally not a tax-efficient route into commercial property because of the double layer of tax suffered – once by the company and secondly by the shareholders. Historically, returns on property company shares have been much more volatile than the underlying property. Yields on property shares also tend to be modest.

UK life company funds

Most life assurance companies have property funds available as links within their life and pensions products. Until property unit trusts first appeared, these life company property funds were the only route for most private investors into commercial property investment. Many life funds have long track records, but they suffer potential tax drawbacks compared with investment in unit trusts and OEICs.

Authorised UK funds

Up until 2007 there was a rapid growth in the number of property unit trusts and OEICs. Some of these invest directly in commercial property, while others invest indirectly, eg through property-related securities such as REITs. Since the end of 2005, it has been possible to include such funds within ISAs, another factor which increased the funds’ popularity.

Unit trusts and OEICs are more tax-efficient than property shares and life funds because they do not pay any tax on their capital gains – all the liability is passed on to the investor. However, the funds pay 20% tax on the income they receive, and this tax is currently not reclaimable by non-taxpayers (including ISA and pension managers). Rgulatory reforms introduced in 2008 mean that this anomaly may soon disappear from some funds.

Offshore investment funds

Alongside the growth in UK funds, in recent years there was a sharp growth in offshore property funds of various types. These funds are generally free of any internal taxation, but may be subject to withholding tax on rental income. Unlike their UK counterparts, many of these funds use borrowing to expand their portfolios. This increases potential returns – in both directions. Many offshore funds have only restricted marketing in the UK because of the Financial Services Authority rules.

Real estate investment trusts (REITs)

REITs are a tax-efficient form of UK property investment company. REITs normally pay no tax on their rental income or capital gains. Instead the liability is passed on to the investor. Thus, in comparison with the traditional property company, the REIT structure results in less tax being paid. At the beginning of 2007, when the REITs legislation came into force, nine listed property companies converted to REITs, including the five largest, which were constituents of the FTSE 100 index. There are now 20 REITs, virtually all of which are property companies which have chosen to convert. It remains to be seen how the REITs market will develop in the UK in the longer term - in some countries, such as the USA and Australia, REITs have largely replaced the traditional property companies.Last Updated