Pick of the PCISs

Posted by Jaimie Kanwar on Thursday, February 02, 2006

After last week's feature on the Government's U-turn over property in SIPPs, this week we look at some alternative Property Collective Investment Schemes (PCISs).

Direct versus indirect property investment

Most people are familiar with the concept of investing directly in property either to receive a regular income through letting, to achieve strong capital gains to provide a nest egg for later years, or both things simultaneously. However, it is also possible to invest indirectly in property through various Property Collective Investment Schemes (PCISs) where a private individual invests into a scheme which then in turn invests that person's money into property on their behalf.

Many people enjoy the process of hunting out great property investments under their own steam and the challenges involved in then managing their overall portfolio. In addition, direct investment in property puts the investor in the driving seat giving them a sense of control over their money.

However, many people underestimate the time and energy needed to be a successful property investor. And for those people who are looking to profit from property investment without the hassle of having a portfolio to manage, indirect property investment could be an option worth exploring offering attractive returns without being too "hands on".

In addition, investing indirectly in property through a PCIS can be a safer option, as most schemes have a multi-layered structure and diversified portolio ensuring risk is minimised overall.

In this article, we look at a couple of key PCIS options - Real Estate Investment Trusts (REITs) and Property Unit Trusts - before ending with a consideration of other property funds on the market.

1. Real Estate Investment Trusts (REITs)

REITs - sometimes known as Property Investment Funds - are stock exchange-quoted companies which directly own property. They provide people with an easier and lower cost way to invest in a diversifed property portfolio than direct property investment. In addition, REITs have the added appeal of being able to trade property assets without paying corporation tax on their profits.

REITs already operate in most major western economies including Japan and the US where, in the case of the latter, they use 90% of their income to pay dividends to investors.

REITs do not currently exist in the UK. But in his December Pre-Budget Report, the Chancellor confirmed that the government intends to introduce legislation for the establishment of REITs to take effect from July 2006. The Government hopes that at this time most listed property companies will convert into REITs.

Through REITs the government aims to:

Improve the quality and quantity of finance for investment in both commercial and residential property
Expand access to a wider range of saving products on a stable and well regulated basis
Ensure the payment of a fair level of tax by the property sector, to protect all tax payers
Support structural change in property markets by reducing costs and improving flexibility and quality for tenants

At this stage the Government is proposing a REIT will take the form of a closed company whose activities are divided into two distinct areas: one involving direct investment in property and the income this investment generates, the other covering all the REIT's other activities, such as property trading, management and development. To qualify as a REIT, a property company must first ring-fence the revenue from the property investment side of its business. This money must then constitute at least 75% of the company's gross income with 95% of its net income being distributed to shareholders. So long as these individuals then pay tax on their receipts, the REIT itself with remain tax exempt. A further stipulation is that 75% of the REIT's capital value must come from the real estate used in its ring-fenced business.

REITs have been very successful in other countries although in most cases they have taken many years to become well established. However, many observers are currently sceptical about the introduction of REITs in the UK.

Ros Rowe, tax partner at PricewaterhouseCoopers, criticised the Government's current restrictive proposals on ownership and gearing in a recent press statement warning these could severely restrict the number of companies that would qualify as a REIT.

Mr Rowe said: “REITs have been widely welcomed within the property sector but some proposed rules in the consultative document are far from ideal. I encourage the Government to consider amending those rules to ensure there is the healthy take up that all sides want.”

Indeed on a recent straw poll at a conference held by PricewaterhouseCoopers only 11% of attendees said that their companies were likely to convert to a REIT next year.

Other observers have voiced concerns that REITs could potentially expose investors to even greater risk by creating the possibility of investors experiencing both negative equity with their own homes at the same time the value of their REITs shares is falling.

This debate is sure to continue for the foreseeable future.

2. Property Unit Trusts

A unit trust is a "pooled" (or "collective") fund made up of assets (usually shares) that are owned by lots of individuals who pool their capital in exchange. It constantly fluctuates in size, depending on how many people choose to invest money into it.

The fund is managed by an authorised fund-management group employing a team of fund managers to decide how the money should be invested.

Unit trust funds rise and fall in price as their investments fluctuate in value. For these reasons, financial advisers suggest money only be invested in unit trusts on a relatively long-term basis and for at least a minimum of five years.

If you can afford to tie your money up like this, however, unit trusts have traditionally delivered a better return than the average cash deposit.

Property unit trusts are a specialised type of unit trusts that invests in property rather than traditional equities like shares. Their main appeal is as a means of avoiding 4% stamp duty when a property unit trust has offshore status. Most funds of this type are based in Jersey where there is already a multibillion-pound offshore property unit trust industry.

The exemption of property unit trusts from stamp duty is intended to help pension and life companies repackage their assets more effectively. However, many property dealers are exploiting the loophole for profit causing the Inland Revenue to threaten a clamp-down. The extent of the abuse causes many industry experts to worry that the Treasury will be too drastic in its measures and damage the legitimate and successful offshore property unit trust industry in the process.

However, typically, this kind of tax avoidance is limited to high-value property deals because of the large costs of structuring the transaction and because of the risks involved.

3. Other property funds

There has been a very significant increase in the level of indirect investment in real estate over the last few years. Also the types of investor involved have widened, to include not only institutions and life companies, but also private equity, high net worth and non-resident investors.

Although indirect property investment is still structured principally through limited partnerships and offshore unit trusts (see above), there are lots of new products rapidly coming on to the market. These vary widely - with investment in both commercial and residential property, use of property in pensions funds and property incorporated with a widely diversified fund portfolio.

For more information on ways of investing indirectly in property, you should consult an FSA-regulated financial advisor.

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