Big landowners enter new territory

Mark mark at
Sat Dec 16 18:39:47 GMT 2006

Big landowners enter new territory

Liz Phillips
Sunday December 10, 2006
The Observer

We British have always been mad about bricks and mortar. Once we've bought
our own house, many of us turn our attention to buy-to-let or holiday

And we still can't get enough of it. This year commercial property has
been in favour, with more than a billion pounds pouring into property
funds. The buzz around bricks and mortar is hardly going to die down next
year when Real Estate Investment Trusts (Reits) are launched in January.

 These will be investment trusts that are likely to own commercial
property such as offices, shops and warehouses, though they can hold
residential property too. Investors will buy shares in them which will
rise or fall depending on the value of the properties and their rental
income, as well as market sentiment about their future performance.

In order to qualify as a Reit, the Chancellor has set out rules stating
that at least three quarters of a trust's income must come from managing a
range of properties, rather than just buying and selling them.

Although they sound new, in fact most of the companies intending to become
Reits will be property companies already quoted on the London stock
market. Big names like Hammerson and British Land, owners of City offices
and shopping centres, have already announced that they will be converting
next year. Even chain stores such as Tesco could put their portfolio of
properties into a Reit. Companies will have to pay 2 per cent of their
total assets to the Treasury to convert to Reits.

So how will they differ from ordinary property companies floated on the
market? The main difference is the tax position: they will be exempt from
paying tax on their rental income and capital gains tax on any profit when
they sell a property in the UK.

Once their gains become tax-free, these property companies should be able
to pay out larger dividends. In fact, some estimate their dividends could
double once they have Reit status, making them attractive to investors
seeking an income. Reits will have to pay at least 90 per cent of their
profit from UK rental income in dividends (taxed at 22 per cent at source,
as with normal dividends). And they can still pay ordinary company
dividends as well. Shareholders will still have to pay income tax on
dividends and capital gains tax over their annual allowance of £8,800 if
they sell at a profit, as they would with other listed company shares.

Fans of these new investment trusts believe the favourable tax position
means that, for the first time, investing in property companies will be
similar to buying property directly.

Reits are already popular in the States, Australia and parts of Europe.
When they were introduced in France, property companies' valuations rose
significantly, according to Nigel Bolton, head of European equities at
Scottish Widows Investment Partnership (SWIP). And Justin Modray, of
financial advisers Bestinvest, says that although the expected boost to
valuations from conversion to Reits status has already been priced into
companies' shares, his research team believes they still look good value.

'Many are still trading at a small discount to the net value of their
assets, whereas their European counterparts are typically trading at
premiums of around 30 per cent,' he says. 'If discounts persist after
companies have converted, we may see some takeover activity.'

But he also has some words of caution. For one thing, commercial property
has had a remarkably strong run in recent years, with rental yields and
property values achieving double-digit growth. The brakes are expected to
go on next year.

Stewart Cowe, who runs the SWIP Property Trust, says: 'This year has
caught many of us by surprise. Returns in 2007 could be as low as 5 per

One reason advisers like an element of commercial property in their
clients' portfolios is that it behaves differently from the stock market.
In fact, historically, property often rises when the market is falling.
But Reits, they say, tend to be more like equities so they won't be as
good at diversifying your investments.

'At the end of the day they are just another property company share with
the tax benefits giving them an improved yield,' says Justine Fearns, of
advisers AWD Chase de Vere. She prefers property funds such as Fidelity
Global Property or Premier Pan European.

'On balance,' says Modray, 'we are reserving judgment on Reits and
suggesting clients do not rush in.' He would rather recommend a global
fund such as Franklin Global Reit.

But Steve Buller, manager of Fidelity's Global Property Fund, says: 'We
believe Reits will prove popular for UK investors looking to diversify
their portfolio as they offer a low-cost and highly liquid method of
investing in property. They are particularly suitable for those looking
for stable income. In addition, limitations on borrowing and restrictions
on allowable investments mean that companies are managed conservatively
and can deliver consistent returns to shareholders.

'We expect to see more companies converting to Reit status, leading to
greater choice for investors.'

Rather than invest in a single company with Reit status, investors can
choose a property fund that holds a number of properties and even some
property company shares.

The largest are Norwich Union Property Trust, with more than £1bn worth of
assets, and the SWIP Property Trust. New Star's property fund is its most
popular fund this year.

All commercial property unit trusts keep back some cash or invest an
element in property company shares to provide liquidity, but if confidence
falls and too many investors tried to cash in, there could be a problem.

Modray explains: 'If everyone tried to sell at the same time they would
have to sell property to fulfil the orders. That would create a delay in
payouts or the fund might have to close.

'Global property funds are a better option for those seeking diversity.
Most people should restrict their holding of these funds to 10-15 per cent
of their portfolio.'

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