COMMENT
Property Investment Becomes More Attractive

By Ed Bowsher (TMFArkle)
January 3, 2006

The British have a long-standing love affair with property. Just look at TV shows such as "Hot Property" and "Property Ladder."

In the last six or seven years many Brits have moved beyond doing up their own home. They have bought investment properties using buy-to-let mortgages, and some people have made big profits.

However, buy-to-let isn't a one-way bet. If you tie up all your money in two or three properties, your risk is very concentrated.

The other problem is gearing. Borrowing to buy is great when times are good, but the landlord could be stretched if he can't find a tenant and property prices are falling.

One solution is investing in a residential property fund. This kind of fund is able to acquire properties across the UK while shareholders can buy small stakes and hence not borrow. Such funds should become far more popular once Real Estate Investment Trusts (REITSs) are launched in January 2007.

What's more, REITs will be able to invest in commercial property too.

The beauty of REITs is that the taxman only takes his cut once. Right now, a property fund or company has to pay corporation tax on its rental income and any chargeable gains. Then the shareholders have to pay income tax on their dividends and capital gains tax too.

Once REITs are introduced, the taxman will only hit the shareholders. The trust won't have to pay anything. Private investors will also be able to put REITs in an ISA which will reduce the tax burden still further.

As you'd expect, there are some catches. As things stand, REITs will have to pay out at least 95% of their net taxable profits in dividends. On top of that, trusts will have to obtain at least 75% of their income from rents, and no shareholder will be able to own more than 10% of the fund. There will also be some restrictions on the trusts' ability to borrow.

The other big issue is the conversion charge. Some property companies such as Hammerson (LSE: HMSO) and Slough Estates (LSE: SLOU) may decide to become REITs. However, Gordon Brown doesn't want to lose any tax revenue, so the companies will have to pay a one-off charge before they can convert. Brown is expected to announce the details of the charge in March 2006 in his next Budget.

The property industry hopes that the Chancellor might also relax some of the other conditions in the budget. Lobbyists argue that the 95% dividend payout threshold is too high given that the equivalent figure in the US is 90%.

But whatever the payout threshold, REITs are a good idea which should help the long-term investor.

Be careful, however. It's always a mistake to invest purely for a tax break. Shares in commercial property companies have already had a strong run in the last 18 months, partly in anticipation of REITs. Some valuations look a little rich. Residential property could also have a tough time in the next few years. And remember that the stock market has outperformed property in the long-term.

I think the best approach is to monitor the property market carefully from January 2007 onwards, and then consider a long-term investment when prices are either falling or at least rising slowly.