UK REITs

The Ultimate Guide

This is a very comprehensive guide to understanding Real Estate Investment Trusts ("REITS").

We're going to cover what they are, what the risks are, how to assess them, and how to invest in them.

If you're new to REITs, this is the guide for you.

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Chapter 1

What is a REIT?

In this chapter we will cover the basics of UK REITs.

We'll cover how REITs are listed companies but with different property focused characteristics compared to traditional company shares

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All REITs are companies with shares listed on a stock exchange

In many ways a REIT is just like any other company that you can buy shares of via the stock market.

Buying a share in a REIT gives you a fraction of ownership of that company with all the legal and financial entitlements that gives you.

REITs differ though in that they have to follow some pretty specific rules.

How REITs are special

To be a REIT the company has to comply with certain rules:

  • 75% of the company’s profit must be generated from rental income
  • 75% of the company’s assets must be properties available to rent
  • 90% of the company’s rental profit must be paid out to shareholders via dividends.

What does this mean?

As 75% of the company's profits must come from rental income and 75% of the company's assets must be available to rent it means we are dealing with a property investment company.

We can be sure that the business primarily makes money by owning properties and renting them out to tenants.

How else can they make money?

In theory, as long as the 75% thresholds are maintained the company can earn the other 25% of their profits (or 25% of their assets) in any way. In practice the main 'other' way that a company registered as a REIT makes money is via property development.

However, because of the ratios the property development side can only be a minor part of the business.

What's that about dividends?

A dividend is a payment made by a company to it's shareholders out of profits.

Normally a company has a lot of discretion as to how much of their profits they pay out in this way. REITs though do not have this flexibility and must pay 90% of their rental profits out each year (they don't have to pay out profits from other activities such as development in the same fixed way).

For the investor this means that the investment generates a good annual income but has limited growth potential as profits cannot be re-invested.

What about taxes?

By becoming a REIT a company doesn't have to pay any Corporation Tax. We explain this more in Chapter 2 - The Advantages of REITs

Chapter Summary

What we've learnt:

  • A REIT is a listed stock market investment.
  • To be a REIT the company must earn most of their money by owning and letting property.
  • A REIT must pay out 90% of its profits each year in the form of dividends.

In Chapter 2 we will look at the wide range of REIT investments available in the UK ...

Chapter 2

Advantages of REITs

In this chapter we will go through the main advantages of investing in REITs.

Advantages include diversification, tax efficiencies and ability to invest in assets that might otherwise be too expensive.

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Advantage #1 - Reliable Income

As we learnt above, a REIT must pay out 90% of it's profits each year in the form of dividends and these profits are derived primarily from rental income.

The really good thing about rental income, at least when renting out to businesses, is that the renter typically has to sign up to a long lease that could be anything from 5 years to 25 years long. Once signed they are legally required to pay the rent until the end of the lease, the only way they can get out of it is to sell the lease to someone else (who will have to pay the same rent) or for the company to go bankrupt.

As such commercial rental income is one of the most reliable types of income around. Though you must remember that companies do go bankrupt and breach leases, so it's never guaranteed!

Advantage #2 - Diversification

A typical investment portfolio is normally made up of investments in company shares and government or corporate bonds. REITs represent a whole different asset class to invest in.

Why Diversify?

Diversification is a technique that reduces risk by allocating investments among various financial instruments, industries, and other categories. It aims to maximize return by investing in different areas that would each react differently to the same event.
 
Most investment professionals agree that, although it does not guarantee against loss, diversification is the most important component of reaching long-range financial goals while minimizing risk.

Source: Investopedia - The importance of diversification

As the Investopedia quote explains, the idea of diversification is to invest in assets that behave differently than others.

For example, let's say you have shares in the second biggest FTSE 100 company which is currently Royal Dutch Shell ("Shell"). The biggest driver of the Shell's share price is likely to be the price of a barrel of oil. Let's say that the price of oil falls massively you could expect the price of Shell shares to decline too, however, this should have almost no impact on the value of UK commercial property that has already been leased out for the next ten years.

One caveat to the diversification point is REITs are stock market investments so often-times when the stock market as a whole goes down, rightly or wrongly, listed REITs decrease too. We discuss this more in Chapter 5 - Risks.

Advantage #3 - Tax Efficiencies

REITs benefit from some pretty special tax advantages.

A normal UK company is required to pay Corporation Tax on profits at a rate of 19%. This corporation tax is paid by the company before any dividends are paid out to investors.

But REITs do not pay any Corporation Tax!

This means only the investor has to pay tax - on the dividend income they receive and any capital gains they earn (from increasing share value).

Though even that tax can be avoided ...

Investing in REITs via an ISA

All UK residents receive an annual ISA allowance (£20,000 in 2018/19). Shares bought via an ISA are shielded from tax on both the dividends received and any capital gains on sale.

REITs are eligible ISA investments - so if you buy a REIT via an ISA neither you or the company pays any tax!

Advantage #4 - Liquidity

Liquidity refers to how easy it is to turn something into cash (ie. to sell it).

One of the big downsides of traditional property investments is that it takes time and money to sell a property.

A REIT, however, can be bought or sold at the click of a button via a share dealing account.

REITS vs Open Ended Investment Trusts

Traditional 'open-ended' property funds (not REITs) differ to REITs because they don't have a constant source of capital.

When investors cash out, the fund has buy the shares from the investor. Since the fund's capital is generally locked up in properties rather than cash this can trigger forced sales well below market value and a loss for all investors.

With a REIT, any sale of shares would be to another investor on the open market, rather than the fund itself. That means the property company still has the same cash and properties on their balance sheet whatever the current share price. As such no properties have to be sold when investors move on.

This liquidity advantage makes REIT investments a lot less risky than traditional property funds. Sure the price of the REIT can (and will) go up and down significantly, but there won’t be any forced selling or halted redemptions.

Advantage #5 - Range of Opportunities

In this guide we haven't yet differentiated between individual REITs, instead we've sort of assumed they are all much the same.

In fact REITs vary significantly.

Here are quick profiles of five different REITs to illustrate this point:

A selection of REITs

REIT Description
British Land An £18bn portfolio of Commercial and Retail properties spread across the UK
Shaftesbury A 14.9 acre portfolio of leisure and retail properties clustered around London's West End
Tritax Big Box Specialises in very large logistics warehouses, each typically larger than 500,000 sq ft and let on long-term leases
Big Yellow Group Operation of 96 self storage stores comprising multiple units rented to individuals and business customers sourced via web enquiries
Primary Healthcare Properties Specialises in primary healthcare properties (eg GP surgeries) often backed by government bodies.

As you can see the five REITs picked are very different investments despite all generating the majority of their income from renting out properties.

British Land is diversified across the UK with exposure to Commercial and Retail properties, therefore it's fortunes will largely be linked to the overall UK property market.

Shaftesbury has a similar model to British Land in terms of the types of property they own but their portfolio is focused entirely in the West End of London. Therefore any investor is making a long term bet on this specific location.

Tritax Big Box only own a fairly rare and niche type of logistics warehouse that is of particular appeal to very large retailers such as e-commerce giants and supermarkets. The management of Tritax Big Box believe their market is largely disconnected to the wider UK economy.

Similarly, Primary Healthcare Properties operates within a specific niche, where they only own properties used by the Healthcare industry and generally letted to the Government, which should (in theory at least) leave them less exposed to economic cycles.

Big Yellow Group is more of a consumer facing businesses, they have big properties that they chop up into smaller units of various sizes and rent these out on short term contracts. This makes them far more exposed to an economic downturn than a REIT that only rents properties out on long term leases.

Our REIT Comparison Table shows all UK REITs currently available and includes a column for the types of property they hold.

Normal investors can't afford £1m+ properties

As a private property investor you might be of the opinion that economic trends are going against high street retail units and small office buildings. Unfortunately these tend to be the only types of commercial property that the average private investor can afford.

Since REITs provide fractional ownership they allow ordinary investors to gain exposure to the huge and very expensive properties that are in demand by modern businesses.

Chapter 3

Investment Returns

In this chapter we will cover the investment returns you can expect to receive when investing in a REIT.

We discuss how the requirements of REITs can limit capital growth.

Finally, we include a short table showing the recent performance of a few REITs.

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Income and Capital Gains

Gains from REITs come in two ways:

  1. Income from dividends - normally paid quarterly
  2. Capital gains from selling shares at a profit

Dividend Income

We've learnt REITs are required to pay out 90% of their rental income in the form of dividends, resulting in a steady stream of income for investors.

Dividends are typically, but not always, paid quarterly.

The size of dividends vary over time

With such a strong link between rental income and dividends, we can be sure if the REITs rental income falls in the medium term then it can be expected that dividends will also decrease.

The reliability of dividends for a particular REIT will be linked to their underlying assets. For this reason you can expect more variation in dividends from one of the storage REITs than a REIT that earns rental income by renting out properties on long term leases to blue-chip clients.

We publish dividend yields in our REIT Comparison Table, the yield is calculated as the dividend per share (actually paid in the prior 12 months) divided by the current share price. So all other things equal, an increase in share price will result in a lower dividend yield.

Capital Gains

Capital Gains come about by selling shares at a profit. So, for example, if you had bought a single share in Tritax Big Box on 1 January 2015 it would have cost you £1.08, you could have then sold that same share for £1.49 on 31 December 2017.

Over the two year period you would have earned a capital gain of £41.

Bear in mind that capital gains can only be realised by selling your shares, this is also when a capital gain would be taxed.

REIT Capital Gains are linked to the underlying property

In Chapter 4 - Analysis and Valuation we discuss how to value REITs. The most important metric when valuing REITs is the Net Asset Value. Keeping it simple - we can describe this as the market value of the properties that the REIT owns less any borrowings.

It follows that the value of shares (and those capital gains) will be driven by property prices. If the property portfolio increases in value then you can expect a share price increase too (it might take a while though), conversely if the value of the portfolio decreases then the shares will also decrease in value.

Without property price increases capital gains will be limited

A typical business, not encumbered by the REITs rules, gets to choose what proportion of their profits to pay out as dividends each year. A company with lots of growth prospects will generally pay little in the way of dividends because they believe they can re-invest that cash themselves for a better overall return. Re-investing profits in this way is how businesses grow over time.

REITs cannot grow in quite the same way because of the 90% dividend rule. That 10% leaves little cash left over to re-invest in new properties. As such even the best run REITs are limited in their upside potential.

REIT Performance in 2017

To see how capital gains and dividends combine to provide the total return we have prepared the table below.

The analysis assumes you had bought the REIT in question on 1 January 2017 and sold it on 31 December 2017.

A selection of REITs showing return if purchased on 01/01/2017 and sold on 31/12/2017

REIT Purchase Price Sale Price Gain per share Dividends per share Total % Return
British Land 636.50 691.50 55 29.42 13.26
Shaftesbury 922 1,044 122 15.45 14.91
Tritax Big Box 140.4 148.9 8.5 6.35 10.58
Big Yellow Group 714 869.50 155.5 29.4 25.90
Primary Health Properties 104.42 110.56 6.14 5.25 10.91

Total % Return = (Sale Price - Purchase Price + Dividends per Share) / Purchase Price x 100

Remember, as always, that past performance is not a guide to future performance. We have included this analysis to aid understanding of the mechanics of dividends and capital gains.

Chapter 4

Analysis and Valuation

In this chapter we will show you how to analyse and value a REIT.

We'll define each of the main metrics that you will want to use and explain how to understand them.

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Price to Book Ratio - Comparing the value of assets to the share price

The Price to Book Ratio is probably the most important measure when valuing REITs.

You can understand it as follows:

Price to Book Ratio = Share Price / Net Asset Value Per Share

The Net Asset Value (sometimes called 'Book Value') is the value of all assets less liabilities. It's a simplification but when considering REITs this is effectively the market value of properties owned less any borrowings.

If a REIT were to sell all their assets in an orderly way, pay off any liabilities and close down then they could be expected to receive the an amount equivalent to the Net Asset Value in cash (ie a break-up value). For all intents and purposes this is the intrinsic value of a REIT. The market value (per the current share price) will move around all the time but over the long term it should tend towards being equal to the Net Asset Value.

The Net Asset Value per Share is simply the Net Asset Value divided by the number of shares issued.

The table below shows the Price to Book Ratio for our five example REITs

Price to Book Ratio Calculations

REIT Share Price Net Asset Value per Share Price to Book Ratio

Live prices provided by Yahoo! Finance

A Price to Book Ratio of more than 1 means the market is giving a value to the company in excess of the break-up value of the assets of that company.

A Price to Book Ratio of less than 1 means the market is giving a value to the company of less than the break-up value of the assets of that company.

What's the correct Price to Book ratio?

It's tempting to assume a Price to Book Ratio of more than 1 means the company is over-valued and less than 1 means it is under-valued. However, sometimes there is a good reason for a high or low book ratio.

Stock market prices don't just take into account the current earning power of a company but also factor in future expectations. A low Price to Book Ratio could mean that the market attributes a lower future value to the properties a REIT owns.

At the time of writing, investors have a negative outlook about the retail property market so more retail focused REITs are trading at a Price to Book Ratio of less than 1.

In a way the Price to Book Ratio is how an accountant making no judgement of the future would value the REIT. That's not a criticism, over the medium term it's a good gauge of REIT share prices but in the short term it could be overlooking a warning sign (or a bargain!).

So the best answer we can give is that over the medium to long term the Price to Book ratio should be approximately 1.

Dividend Yield - Assessing the Annual Income

Dividend Yield is probably the most important consideration for long term REIT investors because it represents the annual payouts they can expect to receive.

Dividend Yield is shown as a percentage, when you see it presented on our REIT Comparison Table or on finance sites you are looking at the yield based on the actual dividends paid out in the last twelve months divided by the current share price.

Here are some things to consider with dividend yields:

  • Just because 'x' amount of dividends were paid out last year is no guarantee that they will be again
  • An unusually high dividend yield (more than 6% at the time of writing) may be a sign that investors expect the dividend to decrease (or it may mean investors are undervaluing the company!)
  • Most companies seek to maintain a fixed dividend, this can be harder for REITs because of the 90% payout rules so more volatility in the dividend payouts should be anticipated.

Below we present the current dividend yields for our selection of five REITs:

Dividend Yields

REIT Dividend Yield

Live prices provided by Yahoo! Finance

The Role of Interest Rates

When interest rates change you can expect the price of REITs to change too, the effect is gradual but discernible.

Why are interest rates relevant?

Investors assess risk and when they see higher risk they want a relatively higher reward. Let's say a hypothetical investor can get a return of 3% per year by keeping their money in a bank saving account, that's about as safe as investments get. Banks do fail but it's very rare and even then the UK government now guarantees a certain amount of savings.

It follows that the investor is going to want to receive a return of more than 3% for investing in a REIT, they might figure that the extra risk they are taking on with the REIT requires a return of at least 2% more than their savings account. So they invest in a REIT that yields 5%.

Now let's say that interest rates go up by 1%, the savings account now offers 4% so they need a yield of 6% from their REIT. The 5% yielding REIT is no longer attractive to them, so they sell it. Lot's of other investors think the same way so the price of the REIT decreases.

Remember that dividend yield is the dividend payout divided by the share price so as the share price decreases (the denominator in our fraction) the resulting yield increases. Eventually the REIT will be yielding 6% and will again be attractive to the investor.

From this example you can see that as interest rates increase the relative value of a REIT is likely to decrease. The inverse is also true, as interest rates decrease the yield on a particular REIT will look more attractive until buyers pile in and the yield is reduced accordingly.

Loan to Value - Assessing indebtedness

One of the big advantages of investing in property is the accessibility and relative cheapness of borrowing. Borrowing allows property owners to afford properties they otherwise couldn’t and to leverage up their returns.

REITs are free to borrow to buy property and will generally report a Loan to Value ("LTV") figure in their accounts.

The LTV ratio compares the level of borrowing to the value of the properties owned. So if a REIT owns £100 million of property and borrowed £25 million then they would have an LTV ratio of 25% (ie £25m / £100m).

You may have seen this ratio when applying for mortgages - where a higher LTV ratio typically means a higher interest rate to compensate the bank for taking on more risk.

The LTV ratio is especially important during periods of declining property prices. This is because when banks lend to companies they tend to stipulate a maximum LTV ratio. If the LTV ratio exceeds that threshold then the bank will require the borrower, in this case the REIT, to pay back some of the loan to reduce the LTV ratio to an acceptable level.

If the REIT does not have the cash available it could force them into a forced sale of properties or additional fundraising, both of which will likely result in a loss of value to existing investors.

If a REIT is particularly over-extended by borrowing too much in a downturn then they could ultimately face bankruptcy making any investments in the REIT worthless.

How to find LTVs

You won't find the LTV presented in normal share screening tools like Google Finance or Bloomberg. Instead you have to dig into the company accounts. We've done this already for our readers and you can see the full list of REITs with their LTV on our main REIT Comparison Table.

We've collated the LTV for our five example REITS below:

Loan to Value

REIT Loan to Value

LTV per most recently published accounts

Operating Margin - Assessing Costs

REITs are not like an investment fund which charge a fixed annual fee.

The costs of a REIT are the admin costs and overheads of the company that owns and manages the properties. The major costs are things like head office costs, management salaries, property management professionals and financing costs.

When assessing REIT investments you should be aware of the costs. You could have two REITs with very similar property portfolios and revenues but vastly different profits due to management costs.

The simplest way to assess costs and operating efficiency is to divide the annual profits with the annual revenues, which gives you an Operating Margin. The higher the ratio the less of the property income is lost to overheads and (other things equal) the more efficiently run the REIT.

Chapter 5

Investment Risks

REITs are not without their risks

In this chapter we will highlight the most common risks to be aware of when investing in REITs.

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Property Price Crashes

With REITs you are ultimately investing in bricks and mortar. In the UK at least, over a long time frame this has been an excellent bet but there have been periods where investors have suffered big losses.

In Chapter 4 - Analysis & Valuation we learnt how REITs can be expected to track their Net Asset Value. When property prices decrease the Net Asset Value of a REIT will also decrease and the share price can be expected to follow.

Most REITs own Commercial property (ie offices and similar) rather than Residential. Historically, Commercial property prices have been more volatile than Residential prices. When an economic downturn hits homeowners still need somewhere to live but when businesses fail or merely scale back there is a sudden loss of demand in the market. This can impact both the sale price of any particular property and it's rental value.

The chart below shows the share price of British Land, one of the biggest REITs in the UK market.

British Land (BLND) Share Price Chart from Google Finance

Had you bought British Land shares on 15/05/2015 and sold on 08/07/2016 you would have lost 33% of your investment (ignoring dividends). Even at the time of writing in late 2018 you would be looking at a capital loss had you bought at that peak.

How to avoid capital loss when investing in REITs

There is no surefire way to avoid capital losses, aside from not investing in the first place. Here are our best suggestions for minimising your risk when buying REITs:

  • Do not buy REITs with a Price to Book Ratio in excess of 1.2x
  • Research the portfolios of the REITs you buy and ask yourself if you would want to buy these properties personally (because that's what buying a REIT is!)
  • Avoid REITs with high (eg greater than 40%) Loan to Value Ratios
  • Understand the market dynamics of the sector the REIT operates in. Shops and restaurants frequently fail, GPs surgeries rarely do.

Management Failure

It's tempting to think of a REIT as some abstract financial instrument but doing so overlooks that they are actually businesses managed by real people.

The Directors of a REIT will be ultimately responsible for which properties are bought and which are sold, as well as deciding the appropriate rent and lease terms.

There is plenty of scope here for the management to make bad decisions that cost investors money, even if they are operating in a sector with loads of potential.

They are also responsible for ensuring the company is run efficiently without unnecessary waste on overheads or management bonuses. This is a fine balance and sometimes managers get it wrong.

Equity Market Correlation

As you know by now, when you buy a REIT you are buying a share in a company listed on the stock market. Beware! Stock markets act weirdly!

Investor sentiment plays a big role in day to day price changes and sometimes that sentiment is just wrong. So imagine a situation where you buy the perfect REIT at a fair price, it owns properties that you feel really good about and they have rented the properties out to top tenants on long leases.

Then let's say there a sudden decrease in oil prices triggered by politics so investors rush to sell shares in big oil companies like BP and Shell. Oil & Gas companies actually make up over 16% of the FTSE 100 so the index as a whole falls enough to spook investors in non-oil sectors.

The result of all this is that the price of the REIT has got caught up in wider market fluctuations when nothing has changed the fundamentals of the investment. For some this would present a buying opportunity but for someone who needs to sell their shares it means a permanent loss.

Check the REIT's "Beta"

If you look up any share on the Yahoo Finance website you will see amongst the Summary statistics an item called Beta. The Beta of a share measures it's correlation to the stock market it sits in.

  1. A Beta of 1 means that a 10% increase/decrease in the index would result in a 10% increase/decrease in the share.
  2. A Beta of 1.5 means that a 10% increase/decrease in the index would result in a 15% increase/decrease in the share.
  3. A Beta of 0.5 means that a 10% increase/decrease in the index would result in a 5% increase/decrease in the share.

Most REITs have a Beta around the 0.5 to 0.7 range, but the higher the Beta the more you can expect the share price to be impacted by wider economic events.

Chapter 6

How to buy REITs

Now you know what a REIT is and how to assess them you might want to invest in some.

You can use any UK stocks and shares account but we recommend using an ISA if possible.

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How to Buy

REITs are just like normal shares quoted on a stock market. You can make REIT investments through any of the normal online share dealing brokers such as Hargreaves Lansdown or Charles Stanley (to name just two). Based solely on price and range of investments available we suggest Charles Stanley.

If you have an ISA you can also buy REITs inside your ISA wrapper for extra tax benefits.

What's an ISA?

An ISA is a tax free savings account. They come in a few forms but for investing in REITs you would want a stocks and shares ISA. The Government allows you to invest up to £20,000 per year into a stock and shares ISA and then within the ISA all gains and dividends earned are tax-free.

The information provided is to aid understanding and collated from a wide variety of sources. We do not guarantee the accuracy, veracity or completeness of any information provided. Use it as a starting point, do no make investment decisions based purely on information on this site. We will not be liable for any loss caused by reliance upon information provided on this site.
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