Real estate investment trusts (REITs) are popular passive income investments and it’s easy to see why. They’re a more straightforward investment than traditional buy-to-let properties.
On top of this, they’re more tax-efficient than other dividend stocks. And that can be a big advantage when it comes to returning cash to shareholders.
Tax
REITs were originally brought into existence in the US to make a booming property market accessible to ordinary individuals. And in a meaningful sense, this is exactly what they do.
Being required to return their rental income to investors as dividends naturally limits their growth opportunities. But in exchange, they don’t have to pay taxes on their profits.
For passive income investors, that’s a big advantage. With other dividend shares, the firm pays tax on its profits before it can return what’s left to investors.
That makes dividends an inefficient way to get cash out of a business, especially for investors without a Stocks and Shares ISA. Companies pay tax on their profits and shareholders pay tax on their income.
This might not sound like much, but it shouldn’t be underestimated. For Diageo, the difference between its annual pre-tax profit and its net income is around £1bn.
That’s almost two-thirds of the amount the firm sends out in dividends each year. So for a REIT, not having to pay this is a big advantage.
Please note that tax treatment depends on the individual circumstances of each client and may be subject to change in future. The content in this article is provided for information purposes only. It is not intended to be, neither does it constitute, any form of tax advice. Readers are responsible for carrying out their own due diligence and for obtaining professional advice before making any investment decisions.
Housing
For investors looking to get into the buy-to-let market, The PRS REIT‘s (LSE:PRSR) an interesting alternative to think about. It has a portfolio of just under 5,500 houses, mostly in the North West.
The occupancy rate’s around 96% and the firm collected 99% of the rent it was due in the last three months. And the majority of its tenants have household incomes above £36,000.
Those are positive signs for future income and there’s more to like as well. Strong Energy Performance Certificate (EPC) ratings on relatively new homes should mean it stays ahead of changes in regulations for some time.
There’s a shortage of UK housing at the moment – including rental housing. And that very much helps PRS in terms of its ability to increase rents each year.
The UK government however, is attempting to do something about this. And if it succeeds in getting near its ambitions, then this could create a challenge for existing property owners.
That’s something to keep in mind. But the company has been increasing its dividend recently, there’s a current yield of just under 4%, and it’s fully covered by the firm’s earnings.
Buy-to-let?
I think REITs should be on every dividend investor’s radar. The significance of being able to distribute cash to investors without being taxed on it shouldn’t be underestimated.
Specifically, The PRS REIT could be a nice alternative to the buy-to-let market. For anyone with a positive long-term view of UK housing, I think considering it is a good idea.
It’s a lot less work and investors can start buying shares with as little as £1. And a ready-made portfolio of quality houses could be a valuable asset over the long term.
