Property based investments

Question 1

5 ways differ to direct investment

Answer 1

• The investment is diversified over a number of different properties.
• Share prices are affected by the quality of the management and the level of borrowing, as well as the underlying asset
• Property shares can be highly geared making the shares more volatile.
• The share prices will rise and fall independently of the underlying asset, depending on supply and demand:
• The company will be liable to corporation tax on capital gains and rental income.

Question 2

3 differences between unit trust and investment trust property

Answer 2

UT - can’t borrow, price of units linked to underlying investment, can invest directly

IT - can borrow for investment, small direct, share price might not be nav

Question 3

how are unit trust and IT taxed?

Answer 3

no CT

Question 4

what is a PAIF

Answer 4

FCA-authorised OEIC that invests mainly
in property (including UK and non-UK REITs)

Question 5

How is PAIF taxed?

Answer 5

point of taxation moves from the fund to
the investor, like directly held property

rental profits and other property-related income are exempt from taxation in the fund.

other taxable income is subject to corporation tax at 20%.

Only OEICs can qualify as PAIFs, so an authorised unit trust would have to convert to
an OEIC.

Question 6

what are the three PAIF distributions and tax

Answer 6

1. property income: this is usually paid net of 20% income tax (non-taxpayers can reclaim the tax or it can be gross,
2. interest income: distributions of interest are paid gross;
3. dividends: paid without the deduction of any tax, i.e. they are also paid gross.

Question 7

what are 4 conditions for a PAIF

Answer 7

• at least 60% of net income in an accounting period must be from the exempt property investment business;
• assets involved in the property investment business must be at least 60% of the total assets held by the PAIF
• its shares must be widely held, with no corporate investor holding 10% or more of the fund’s NAV.

Only OEICs can qualify as PAIFs, so an authorised unit trust would have to convert

Question 8

4 features of life co property

Answer 8

• The value of units is directly linked to the value of the property in the portfolio via reg valuations
• The funds cannot borrow money.
• Liquidity is significantly higher than with direct property investment, although encashment can suspend
• Any income and capital gains are subject to up to 20% tax within the fund.

Question 9

offshore investment cos explain why and tax 5

Answer 9

allows them to invest 100% of their assets directly in property rather than property cos

The companies usually obtain a UK stock market listing, so that their shares are eligible for inclusion in ISAs.

results in the fund paying less corporation tax than an
onshore company,

not liable to UK corporation tax, but is liable to UK income tax at the basic rate on rental income from UK property

no cgt

Question 10

3 aims of a reit

Answer 10

• provides a liquid market in property investment;
• is widely accessible by the private investor; and
• has a tax treatment that is closely aligned to the tax direct
  investment in property.

Question 11

4 structures of reit

Answer 11

REITs must be closed-ended companies

resident in the UK for tax purposes

can only issue one class of ordinary share.

must be listed on a recognised stock exchange.

Question 12

explain 2 elements of reits and CT

Answer 12

ring-fenced property letting business, which is exempt from corporation tax

any other activities, e.g. the provision of property management services subject to CT

Question 13

3 conditions to qualify as REIT

Answer 13

• At least 75% of the company’s total gross profits must be from the property rental business (the tax-exempt part
• tax-exempt part of the business must be at least 75% of the total value of the assets (ignoring secured
  loans)
• interest on borrowings has to be at least 125%, covered by rental profits (before deducting interest costs)

Question 14

Internal taxation of reit 3

Answer 14

90% of the profits of the tax-exempt income part must be distributed as a dividend within twelve months

Property can be developed tax-exempt part of the business, if it is added to the property portfolio.

If a property is developed to be sold for a profit, then the disposal would be treated as nontax exempt unless 3 years

Question 15

investor tax of reit 2

Answer 15

ring fenced at 20% unless gross isa PPP (no CT)

Non ring fenced usual dividend (paid CT)

Question 16

List 9 advantages of investing into a REIT rather than directly into a buy to let
property portfolio.

Answer 16

• Diversification
• Professional Management.
• Greater liquidity so can buy and sell on a daily basis
• Partial sale possible
• Less administration/involvement
• Can invest small/regular amounts.
• Provides investor protection due to greater regulation.
• Capital Gains Tax savings by being able to time sale of
  REITs
• Buying and selling/ongoing costs are lower.

Question 17

State 9 requirements a UK REITs must meet to become available to a UK investor

Answer 17

• REITs must be resident in UK for tax purposes.
• Must be a close-end fund cannot be open
  ended investment company (OEICs).
• Listed on a recognised Exchange.
• Only issue one class of ordinary shares and preference shares.
• Distribute 90% of taxable income to investors each year.
• 75% of profits and gross assets must come from property rental business.
• Must not be a close company/controlled by five or fewer participants.
• Contain at least three rental properties and not involve a property representing more than 40% of the total value
• The profit to financing cost ratio must not be lower than 1.25.

Question 18

Explain briefly 4 potential implications of buying shares in REITs that are trading at
a premium to net asset value.

Answer 18

• If sentiment changes and demand for the REIT shares reduces,
• Its premium may reduce or move to a discount.
• This will cause the investor to suffer a capital loss, regardless of any move in the net asset value.
• And, if the NAV is to fall and the premium narrows, this will enhance the loss.

Question 19

State three types of borrowing, other than from a bank, that a REITs could utilise.

Answer 19

• The REIT could issue corporate bonds
• The REIT could issue debentures
• The REIT could issue zero dividend preference shares

Question 20

3 potential drawbacks for a REITs should it borrow from a bank compared to raising money by issuing bonds.

Answer 20

• The loans may be secured against the properties
• Bank loans tend to be shorter term than bonds;
• Interest rates on bank loans are likely to be variable and could increase, whereas bonds are fixed-interest securities.

Question 21

Explain the 5 rules a REIT must follow when distributing income, and the taxation
consequences

Answer 21

• The REIT must distribute 90% of its rental income from the ring-fenced property lettings element.
• Within the ring-fenced property lettings element, the fund pays no CT.
• This is paid out as income net of 20% tax, and subject to tax at the rates of 0%, 20%, 40%, and 45%.
• The dividend allowance is not available to offset this.
• Payment from the non-lettings property management business is paid out gross as a normal dividend.

Question 22

Explain the risks the investor should consider on
disposal of a REIT ONE and an OEIC THREE. Ignore taxation

Answer 22

• The REIT share price is subject to supply and demand. In a weak market, the share price may trade at a discount its NAV
• Mangers may not have sufficient cash to pay sellers
• Managers may not be able to sell property, and if they can, they may be forced to sell it below its fair value,
• An OEIC may apply a dilution levy on exit from the fund.