GORDON BROWN confirmed last week that investors will be able to choose a new type of tax-efficient property fund from January next year, writes Kathryn Cooper.

The chancellor published final details of real-estate investment trusts (Reits), which will invest in commercial and residential property and have tax advantages over some existing schemes. Reits have already proved popular in America, Germany and Japan.

Shares in listed property companies such as Land Securities, British Land and Hammerson jumped 10% after Brown’s announcement because many will be able to convert into Reits. Other companies with big property portfolios such as Tesco, headed by Sir Terry Leahy, are also expected to transfer them into Reits.

Property-fund managers, however, were lukewarm. They said there were too many holes in the Reit rules to make them worthwhile.

We explain how Reits will work and whether they are worth waiting for.

What exactly is a Reit?

Reits will pool investors’ assets to buy a portfolio of properties, which will be let to companies or individuals. Reit shares will be listed on the stock market and bought and sold like any other shares.

What are the tax advantages?

At present, property companies pay corporation tax on their rent and any profits when their properties are sold.

Reits, however, will be free from corporation tax as long as they distribute 90% of their profits to investors. Brown reduced this from 95%, which pleased property companies.

Many firms are now expected to switch to Reit status to escape corporation tax, although they will have to pay a conversion charge of 2% of the value of their investment properties to do so.

There will also be benefits for investors. Dividends from shares in property firms are treated as though they have had basic-rate tax deducted. This cannot be reclaimed, even if you hold shares in an Isa or pension.

Dividends on Reits will be treated differently. Basic-rate income tax of 22% will be deducted at source and higher-rate taxpayers will have to pay a further 18%, but investors will be able to reclaim the tax if they invest via a pension or an Isa.

Justin Modray of Bestinvest, an adviser, said: “Reits will benefit investors who hold property through a pension or Isa because they will be able to reclaim the tax deducted at source.”

And how will Reits compare with property unit trusts?

Income from unit trusts is treated the same way as company dividends, so investors cannot reclaim basic-rate tax even if they invest within a pension or an Isa. With a Reit, the tax can be reclaimed.

However, advisers argue that direct-property unit trusts have advantages that could outweigh the tax benefits of Reits. Brian Dennehy of Dennehy Weller said: “Shares in Reits are likely to perform like shares in property companies, which means they will be more volatile than direct property funds.”

What about offshore property schemes?

Offshore property companies, unlike onshore firms and property funds, usually allow pensions and Isas to invest in bricks and mortar free from tax. The tax treatment is exactly the same as with a Reit and there will be no benefit to switching.

Peter Roscrow at Close Property Management said: “Our offshore Close High Income Properties fund would have to pay a conversion charge of 2% to switch, at a cost of about £4m.”

So should I invest in commercial property and should I wait for a Reit?

Advisers say it is worth having some commercial property in your portfolio — up to 20% — because it should be less volatile than equities and deliver better returns than other “stable” investments such as bonds.

However, Reits will be closer to shares than to direct property, so investors who are not prepared to accept that level of volatility should consider a direct property unit trust instead — despite the tax disadvantages.

Aren’t some fund managers already promoting Reit funds?

Yes, Fidelity recently launched a Global Property fund, which invests in a portfolio of Reits from other countries such as America and Japan. Morley Fund Management followed suit with the Aviva Global Reit fund last week. Both funds will be able to invest in UK Reits once they are launched.

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