WEDNESDAY’S Budget brought mixed blessings for the commercial property industry. The good news was simple. After a 20-year campaign to get tax-efficient real estate investment trusts (REITs) introduced in the UK, the property industry received a strong hint that the Labour Government may deliver this holiest of grails.

In a discussion paper released on Wednesday, the Government confirmed that REITs were likely to be introduced in the UK next year. And it came up with the skeleton of a structure that could work. In a discussion paper, the Treasury said that there would be no restrictions on the kind of property that can be put in a REIT, paving the way for hotel, shopping centre, offices, or social housing trusts. There will also be few restrictions on development activity. Even better, the Treasury has adopted the US name for the trusts rather than last year’s cringe-worthy working title: Property Investment Funds, or PIFs.

REITs are attractive to property investors because typically they are exempt from capital gains tax and tax on property rental income, in return for which they distribute most of their income as dividends. In other countries, REIT-type vehicles tend to gain a higher stock market rating than property shares do in the UK.

Nevertheless, many crucial issues need to be thrashed out. The Treasury wants REITs to be tax neutral and the thorny issue of an entry charge for companies wishing to convert has to be discussed. There may also be restrictions on gearing.

Unfortunately for property groups, the carrot of a UK REIT coincided with a twin-track clampdown on stamp duty avoidance. Stamp duty relief for commercial property deals in disadvantaged areas was abolished without warning, sending property stocks into a tailspin on the day of the Budget. Meanwhile, further stamp duty avoidance loopholes were closed and the property industry was told that any new wheezes to avoid stamp tax would have to be disclosed. The upshot is that many listed companies that inflated the value of their portfolios as a result of the tax break on commercial property deals in disadvantaged areas will now have to deflate them, and, in future, more companies will have to pay more stamp tax, increasing the cost of deals.

The stamp duty blow comes at a time when office blocks and shopping centres are looking increasingly overpriced in the UK. Prime property rental yields have hit a 20-year low according to CB Richard Ellis — driven down by the weight of money-chasing deals. Top-rated property entrepreneurs such as Gerald Ronson and Nick Leslau are selling fast, disposing of swaths of property to eager buyers at high prices.

Falling rental yields have led some property groups to seek higher-risk ventures that will deliver higher returns. A group of pension and investment funds, and some private buyers, are buying office blocks in Prague, Warsaw, Bucharest and Moscow because they offer higher returns. They argue that the blocks offer good value because they are let to blue-chip international companies and financing rates in the eurozone are cheaper than back home. But the leases are shorter, which increases the risks, and it is likely that some investors will get their fingers burnt.

Optimistic sections of the property industry argue that rising values in the UK and increasing interflow of cash between foreign countries is part of a fundamental re-rating of property. They say that investors have woken up to the attractions of property amid a low interest rate and low inflation environment, and that the process will be enhanced further with the introduction of REITs. Provided that interest rates remain low, property values are unlikely to crash, particularly in prime locations. But if the equity markets pick up significantly, investors may be lured away from property.

After a strong run last year, property shares are trading at an average 9 per cent discount to the underlying net asset value of their respective companies — well below the 35 per cent discount at the start of last year. What is more, they yield only 2.54 per cent on average — much less than the 3.07 average for the FTSE all-share index. As a result, most shares look fully valued and after the strong run last year it remains wise to lock in some profits.

Looking forward, the best performers are likely to be companies with exposure to the recovering Central London property market, such as Land Securities, British Land and Great Portland.

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