The right type of income investment depends on two important considerations. The first is your investment horizon. Your asset allocation will depend on the amount of time you plan on being invested. The closer you get to cashing out your investment, the less volatility you can afford. The second is your tax situation. Income from property ETFs is slightly more complex than just dividend income.
In the first post of this series on income ETFs, we investigated local ETFs tracking companies that have historically paid dividends. Since companies aren’t required by law to distribute dividends, dividend income can be harder to pin down. Real Estate Investment Trusts (REITs), on the other hand, are required by law to pay most of their annual income to shareholders. This ensures a more predictable income stream, but with more complex tax considerations. There are a number of property ETFs available on the JSE. In this post we’ll check under the hood of this type of investment.
Property as an asset class
Listed property is appealing as an income investment because of rental income. The idea is that a listed property company would rent out commercial, retail or residential space. The income earned from these assets are paid out to investors. Theoretically these companies can have tenants as long as they have buildings, which means the income never dries up.
From an asset class perspective, listed property is considered a safer investment than an ordinary share investment. Listed property companies own assets in the form of buildings and land that can be sold should a company fail. In the case of real estate investment trusts (REITs) for example, 75% of the company’s income has to come from property directly or indirectly owned.
For investors nearing the end of their investment horizon, property is considered slightly safer than ordinary shares. However, because property companies are subject to the forces of supply and demand, both in terms of its share price and occupancy of the physical buildings, these companies are still subject to volatility. Properties also have a higher degree of single exposure risk, because large properties like those listed property companies invest in, are illiquid. Should a company hold most of its assets in an area that quickly deteriorates, it might struggle not only to find tenants, but also to sell the loss-making assets.
Property and tax
Income received from REITs is taxed at your income tax rate. Income earned from property companies that don’t have REIT status is treated as interest. After the initial R23,800 tax exemption, income received from these companies is also taxed at your income tax rate. This rate could be significantly higher than the 20% dividend withholding tax paid on ordinary dividends. However, property companies pay out higher distributions more frequently. Even after tax, these investments could prove to be a better source of income than ordinary dividends.
Mike Brown, managing director of etfSA.co.za explains how this tax treatment is applied to ETFs.
“A property REIT is effectively a collective investment scheme trust and income is passed through the trust in the form in which it is received, to participatory interest holders.
This means a property REIT can distribute income in three ways:
- Dividends it receives from investment in other property companies and REITS are distributed as dividend income. Typically, the withholding tax on dividends (20%) has already been applied.
- Distribution of mainly rental income which is distributed as normal income and has to be added to the taxable income of the taxpayer, who receives this income from his property REIT investment. The tax rate of the individual taxpayer then applies.
- Interest income received in the REIT is passed through to the investor in this form. The investor reflects this as interest income and the individual interest rate exemption applies up to the exemption limit.
The listed property REIT will fully disclose the nature of its distribution in SENS announcements and in the data released to the JSE, custodians, etc. The tax certificate issued to the investor at the end of the tax year will reflect the type of distributions made for tax purposes.
For a JSE listed property ETF, the information released to taxpayers is a sum of all REIT distributions received in the Property ETF and the investor is left in the same position as if they invested in the listed property REIT independently and separately.
This reasonably complex treatment of the distributions paid by REITs is a bit of an issue for some investors, but fortunately listed property companies tend to grow their asset base or NAV regularly which means the capital value of the REIT appreciates consistently. Only when the investor sells the REIT or the ETF does CGT apply.
In practice, all the FTSE/JSE property indices only include listed REIT properties, so the aspect of non-REIT property companies does not apply.”
Listed property ETFs and distributions
Locally, investors investors are spoiled for choice when it comes to property ETFs. Not only have the number of international offerings increased significantly over the past few years, but access to real estate opportunities on the rest of the African continent has also become available, thanks to Cloud Atlas.
|Cloud Atlas AMI Real Estate ex-SA (AMIRE)||
|CoreShares PropTrax SAPY (SAPY)||
|CoreShares PropTrax Ten (PTXTEN)||
|CoreShares S&P Global Property (GLPROP)||
|Satrix Property (STXPRO)||
|STANLIB Global REIT Index (ETFGRE)||
|Stanlib SA Property (STPROP)||
|Sygnia Itrix Global Property (SYGP)||
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