The short answer to this question is, yes. They are both trusts and they both invest in property. The main difference when it comes to terminology is whether the property investment trust is publicly listed on the Australian Stock Exchange (ASX) or not. A property investment trust that is listed on a stock exchange is call a REIT. A private property investment trust is often called an unlisted property trust.
A REIT stands for a real estate investment trust. In Australia, a property investor can invest not only in individual REITs, but also in indices. A REIT index represents a portfolio of REITs in the same way the S&P500 represents a portfolio of the top 500 stocks in the USA.
Investing in property through a property investment trust is a complex game, but with the right strategy, can be a very rewarding one.
Essential Property Investment Trusts to keep in mind
If you’re considering setting up your own property investment trust, you need to keep in mind that:
- They can cost a pretty penny to set up and manage
- They require a formal deed that outlines the operations
- They require a trustee that will handle all administrative duties
- They protect your assets
- You won’t be able to easily dissolve or change the trust once it’s set up
You should also know that you can choose among three types of trusts:
- Discretionary Trust – where the trustees can distribute income and capital gains in a tax-effective way and assets will be protected. Beneficiaries who get capital gains may claim the 50% CGT discount for assets they’ve owned for over a year.
- Unit Trust – where the trustee holds and manages the assets for the unitholders. That means that this kind of trust pre-determines the entitlements of unitholders, which may be for capital, income, or both. It’s a common option among unrelated parties who run a business together and managed funds. REITs are a subset of these kinds of trusts.
- Hybrid Trust – which can be hybrid discretionary or unit trusts. The former is the most common type and it combines the best features of discretionary and unit trusts. As such, it provides flexible tax planning.
The Advantages and Disadvantages of Discretionary Trusts
Discretionary trusts are a good option for those who make a high income and have adult children or retired parents, and people who are in a lower tax bracket within their network. Remember, this type of trust distributes profits more tax-effectively.
A discretionary trust is also a good option for those who have risk because it limits liability greatly and provides asset protection. So, if you have a higher risk of getting into financial or legal trouble, investing through a trust can be the right move.
To help you decide, here’s an overview of the advantages and disadvantages:
The Advantages and Disadvantages of Unit Trusts
A unit trust can be a good option for individuals who are unrelated but want to invest in property together. This type of personal financing structure will allow them to have a fixed interest in the property. In other words, they will know exactly what they will receive. REITs are a good examples of a unit trust.
Unit trusts are similar to discretionary trusts. They provide asset protection, so it’s a good option for people with risk attached to them. Here’s an overview of the advantages and disadvantages we discussed earlier:
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Assessing the merits of investing in property using property investment trusts
Using the Strategic Investors Personal Financing Structure scorecard, we score the use of property investment trusts as a legal entity. As always, our assessment is aimed at a general audience. Remember to seek professional advice when formulating your own strategy.
An additional factor to remember is, that our scoring represents the average of the entire spectrum of property investment trusts. Much like investing in property as a group, there is a large variety. From the smallest, single trustee unlisted property investment trust to the largest REIT listed on the ASX, all are considered in this scoring.
- Leverage: It is possible to get a mortgage when investing as a property investment trust. But the list of lenders who offer loans to trusts is much lower than the number of lenders willing to lend to individuals or joint investors. There are also often additional fees when it comes to lending to a trust, because of the additional amount of paperwork required. Similar to how property investment companies with directors who are shareholders, adult beneficiaries of the trust may be required to act as a guarantor of the loan. Our general advice score for Leverage: 1/10 for Leverage.
- Compliance: The level of compliance of a property investment trust is high compared to other personal financing structures. Event when it comes to REITs, an individual investor would be indirectly paying for the cost of the compliance as a trust expense. Our general advice score: 2/10 for Compliance.
- Setup Costs: A high level of compliance generally means that there are a lot of setup costs to meet compliance standards. Therefore, our general advice score would be similar to the compliance score. Our general advice score for Setup Costs: 3/10 for Setup Costs.
- Asset Protection: This is a major benefit to property portfolio investors when it comes to investing through a property investment trust. A trust is its own legal entity, this is why property investors have limited liability. The level of asset protection can be increased if the trustee of the trust is a company. Our general advice score: 9/10 for Asset Protection.
- Property Taxes: Other than the disadvantage that negative returns on property are trapped in the trust, tax efficient income distribution coupled with the ability to benefit from the 50% CGT discount on property make investing in property through a property investment trust a very attractive option. Our general advice score: 9/10 for Tax.
- Liquidity and Flexibility: Property investment trusts offer a great deal of liquidity and flexibility when it comes to property investment. Because ownership rests with the trust, with the real estate investor being a beneficiary (in the case of a discretionary trust) or a unit holder (in the case of unit trusts), ownership can be transferred on paper instead of the need to change owners on the title deed. Our general advice score: 8/10 for Liquidity and Flexibility.
- Wealth Transfer: The ease and efficiency with which property wealth can be transferred when investing through property investment trusts is a major reason this personal financing structure is such a popular choice for property investors. Our general advice score is 9/10 for Wealth Transfer.
Our verdict on investing in property through a Property Investment Trust
Our general advice verdict investing in property through a property investment trust is 6/10.
Always seek professional advice when forming your own property investment strategy, so that you have something that is tailored to your personal circumstances and financial aspirations.
We conclude some closing remarks for real estate investors with different levels of investment property experience.
Verdict for property investors who are beginners
Investors who fit this category generally require lower levels of commitment, in terms of both compliance and setup costs, when it comes to real estate investment. Setup costs are high, and compliance requirements are onerous. Factoring that REITs fall under this category (which makes it easier to invest in property this way), our general advice score is 3/10. Remember, REITs are very large investment vehicles, a beginner often invests into something that may not suit their risk profile if REITs are their only exposure to property.
Verdict for property investors who are experts
For advanced property investors who have a need for high asset protection, efficient tax distribution on property investment income and easy and efficient wealth transfer, this is one of the best legal entities to choose when investing in property. Our general advice score for this group of investors is 9/10.
