GORDON BROWN’S Pre-Budget Report will be a mixed bag for the property industry. On the plus side, the Chancellor is expected to give the green light for the introduction of tax-efficient real estate investment trusts (Reits).

MPs hope that Reits will give ordinary investors a safe way to invest in property. They also hope that the trusts will help to stem the tide of money flowing into offshore property funds.

Typically, Reits are exempt from capital gains tax and tax on rental income, in return for which the majority of their income must be distributed to investors through dividends, which are then taxed in the hands of the recipients. But while the principle is relatively uncontroversial, working out the detail has proved tricky and it seems unlikely that the Treasury will have an oven-ready product on Monday.

Nevertheless, consensus is emerging on the likely shape of the new vehicles. First, the Treasury will probably give the go-ahead only for listed Reits — at least at the start. It is also likely to impose limits on the amount of debt a trust can take on and how much development activity it can undertake.

To ensure that Reits are tax-neutral, property groups will have to pay a conversion tax. If the Treasury is smart it will be based on a percentage of gross asset value, rather than on a company’s inherent capital gains liabilities. Property analysts estimate that the major UK listed property stocks have about £65billion of gross assets between them. Shares in listed property companies have enjoyed a bumper year, comfortably outperforming the FTSE all-share index. As a result the property companies are now trading at an average discount of 10 per cent to their underlying net asset value — half the long-term average.

Nevertheless, despite the strong share price run, which has been helped by soaring property values, Reit fever is not totally priced in.

If Reits do proceed, a greater number of property company shares should trade at around their net asset value rather than at a discount, and share prices should rise.

Nevertheless, those hoping for a seismic shift in the performance of listed property stocks may be disappointed.

In France, many Siics (the French version of Reits) trade at substantial premiums to net asset value. This is partly because Siics tend to offer high yields compared with government bonds.

In Britain, commercial property yields have been squeezed down to record lows by voracious demand from investors. This may mean that, even though Reits will be required to pay out the majority of their income as dividends, the stocks will still yield less than bonds.

Because Reits are tax-efficient, their biggest beneficiaries are likely to be companies such as Land Securities, which pay a lot of tax.

Smaller, entrepreneurial companies such as Helical Bar or St Modwen, may find that the cost of converting to a Reit outweighs the benefits.

On the downside for property companies and housebuilders, the Chancellor looks set to press ahead with consultation on a new windfall tax on landowners, which would be levied on the uplift in value of a piece of land once it is granted planning permission.

In the commercial sector, this will hit hardest the companies that carry out the most development.

The giants of the industry — Hammerson, Land Securities, Liberty International and British Land — all have big development programmes, but these represent a comparatively small proportion of their total group assets. By contrast, smaller companies, again such as St Modwen and Helical Bar, could be stung most by a development land tax because they are experts at getting planning permission for a change of use from, say, industrial to residential, which pushes up the value of the land.

Much will depend on the rate at which the tax is levied. If, as mooted this week, it is about 20 per cent, analysts estimate this could lop about 5 per cent off developers’ profits.

Many property companies fear such a tax would prove counter-productive because it may discourage developers from proceeding with new schemes.

However, if there was a reduction in development activity, it might boost the value of existing completed projects, benefiting companies such as British Land and Liberty International, which have large portfolios of completed blue-chip investment assets.

Housebuilders are likely to be hit harder than commercial property stocks by a development land tax. Most builders have large portfolios of land with planning permission which should not be affected. But they also have portfolios of so-called strategic land, which has not yet received planning permission.

Many builders agree options to buy the land once planning permission has been received. At this point they agree a price with the landowner.

In theory, the tax would be borne by the farmer or owner of the site. But if the tax discourages landowners from selling up, it may reduce the supply of land available for housebuilding and push land prices up. This would inevitably act as a squeeze on housebuilders’ profit margins.

The Chancellor is unlikely to announce the full details of Reits on Monday, which may disappoint investors in the short term. But over the next 12 to 18 months further progress should be made, which will help to boost share prices, albeit not as substantially as some may have hoped.

Any good news on Reits should outweigh any difficulties created by a development land tax. The Treasury will be well aware that four previous attempts to levy this tax have failed and will be keen to modify any proposals it has in mind to ensure they do not act as a brake on development.

Explore Markets

• United States

• Europe

• Japan

• China

• Russia

• The Gulf

• India

• Africa

Times Recommends

• Lies and cover-up at MG Rover exposed by report
• High oil prices push manufacturing costs up
• Primark founder steps down as chief executive