REAL ESTATE INVESTMENT TRUSTS

Being a property owner has never been this easy. Bring your R50 or R5m

The average investor can most likely not invest in a mega-mall like Sandton City or East Rand Mall. Neither buy a R20 million property cash or even qualify for that kind of debt-finance. Along comes Real Estate Investment Trusts aka REITs and makes the impossible possible.

A REIT is a company that derives income from the ownership, trading, and development of income producing real estate assets. REITs offer investors exposure to real estate through shares listed on the Johannesburg Stock Exchange (JSE). Investors can thus access the physical property market without the hassles and costs of buying direct physical property.

 

The business model of a REIT is really simple.

1. Own a portfolio of properties. These include shopping centres, industrial parks, office buildings, residential units
2. The properties generate rental income
3. The REIT pays expenses like rates and taxes, electricity, repairs and maintenance etc.
4. The REIT pays interest on the debt if the buildings have mortgage loans
5. Pay out more than 75% of the profits to investors/shareholders

Tax rules are different for REITs

• Special legislation allows REITs to pay out a dividend without incurring income tax within the company itself. The dividend is taxed in the hands of the investor as normal taxable income. This allows all earnings to flow through to investors without attracting income tax at the company level.
• An important point is that when a REIT sells an investment property, it does not attract Capital Gains Tax (CGT) on any profit from that sale. Therefore, investors benefit since the capital in the fund is reinvested without the erosion of capital due to CGT. Investors will still attract CGT on the sale of their REIT shares as with any other share trading activity.

Advantages and Disadvantages of REIT Investing

There is no such thing as the perfect investment vehicle. REITs are no exception.

I have listed the main benefits and drawbacks in the attached image too for ease of reference

Advantages

• Strong income yields Because REITs must pay out more than 75% of their income, they tend to have yields in excess of 6%.
• Trades on a stock exchange The benefits of being listed on an exchange are liquidity & transparency. Shares can be bought and sold much easier than buying/selling an actual property. Listed entities must comply with strict financial reporting requirements, so you can trust the information given to you.
• Diversification into property with low capital investment needed.
• Effortless No tenant drama. Ask any landlord who deals with tenants one-on-one.
• REITs own hard, tangible assets, such as land and buildings, and often sign their tenants to long-term lease contracts.

Disadvantages

• Yield taxed as regular income at marginal tax rate. You do not pay the 20% dividends withholding tax on REIT dividends. You will however pay tax at your marginal tax rate, that could be higher than 20%.
• Weak Growth - REITs must pay out 75% of their profits to investors. That leaves little money for growing the portfolio by buying more properties.
• No control over returns or performance. You trust a management team to do this for you, so unlike with physical property, you give some of your power away with a REIT.
• Interest Rate Sensitivity  Rising interest rates typically have a negative impact on REIT performance.
• Potential for high fee structures  Some REITs have large fee structures that can detract from investor returns. Doing your research and understanding how the management teams are incentivised is important.

Souls favourite REITs

Vukile Property Fund - High-quality, low-risk retail REIT operating malls in South Africa (49%) and Spain (51%)

Fairvest Properties - Wide range of retail, office and industrial tenants located throughout South Africa. Strong focus on the township economy.

Dipula Income Fund - Diversified portfolio of retail, office, industrial and rental residential assets located across all provinces in South Africa. The majority are located in Gauteng.

Balwin Properties - The largest sectional title developer in South Africa.

Redefine - Premium retail, office and industrial properties which are strategically spread across South Africas major metropolitan areas.

Disclaimer: Nothing in this article should be seen as financial advice. Everything stated is for educational purposes. Only opinions are expressed.