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Guide to Property Funds

5. What are Property Funds?
A property fund is a collective investment scheme with a portfolio comprising mainly of direct property but may also include other property related interests. Property funds take a number of different legal structures depending on their domicile and target customer. The following are the most common forms of property fund:

• Unit Trust;
• Open-Ended Investment Company;
• Limited Partnership;

6. What choice do investors have when looking at property funds and their underlying assets?
There is a wide variety of different types of property fund, from specialist funds to general commercial property. Most have a wide commercial property base, thus offering investors a sufficient variety of underlying assets to build a diversified portfolio of property investments. Information on the investment objectives and restrictions, the current holdings and the type of investor for which the fund is suitable is available to potential investors prior to investing.

7. What are Unit Trusts?
A unit trust is a collective investment scheme under which the property is held on trust for the participants. Unit trusts with trustees resident in the UK may be authorised or unauthorised. If the trustees are not resident in the UK then a unit trust is an offshore fund.

8. What are Open-Ended Investment Companies (OEIC)?
An OEIC is similar to a unit trust in many ways but is structured as a corporate entity instead of a trust. As with a unit trust, an OEIC resident in the UK may be authorised or unauthorised and if it is not resident in the UK it is an offshore fund. Somewhat confusingly OEICs are also referred to as Investment Companies with Variable Capital (ICVC) where the OEIC is also a UCITS.

9. What are Limited Partnerships?
Limited Partnerships provide a tax transparent unregulated vehicle for collective property investment suitable for institutional investors. They vary in their structure, but have in common a general partner with unlimited liability in respect of the partnership. They also have one or more limited partners whose liability is limited to the extent of their capital invested. The limited partners commonly take the form of feeder funds through which investors enter the arrangement. LPs normally have a pre-determined life although this can usually be extended subject to the agreement of the partners.

LPs are tax transparent so there is no tax within the vehicle. Each partner is taxed as if they held their share of the partnership assets directly. Stamp duty land tax, currently 4%, is payable on certain transfers of partnership interest

10. Why are some funds authorised?
Authorisation is necessary in order to market funds to the general public. The Financial Services Authority (FSA) has the power to authorise and regulate all types of authorised fund in the UK. The rules governing the constitution, investment powers and operations of authorised funds are laid down in the FSA’s Collective Investment Schemes Sourcebook (COLL). Authorised funds are shown in bold on our member funds page. Authorised funds in both unit trust and OEIC form are categorised as follows:

• UCITS;
• Non-UCITS Retail Schemes;
• Qualified Investor Schemes;

UCITS cannot invest in property directly; Non-UCITS Retail Schemes and Qualified Investor Schemes can.

Authorised funds are exempt from tax on capital gains but pay corporation tax at a special rate of 20% on income, net of expenses. Investors receive income in the form of dividend distributions with a 10% notional tax credit, may pay stamp duty reserve tax, currently 0.5%, when buying units and are potentially liable to tax on capital gains realised on the sale of their investment. Before the advent of PAIFs, authorised funds were inefficient vehicles for tax exempt investors wishing to invest in property.

11. What is a Property Authorised Investment Fund (PAIF)?
A PAIF is an authorised OEIC investing mainly in property or property related interests and that has elected to be a PAIF. Provided certain conditions are met a PAIF is exempt from tax on the income arising from its property related assets. This serves to eliminate the inefficiencies of authorised funds for tax exempt investors.

12. What if a fund is not authorised?
Then it is an unauthorised fund and cannot be marketed to the general public. Whilst the Operator/Manager of both authorised and unauthorised funds are regulated by FSA, an unauthorised fund itself will not be subject to the regulations set down by the FSA. Instead an unauthorised fund is governed by the requirements of the instrument constituting the scheme. Accordingly, the fund may be run with more flexible investment objectives and restrictions in order to meet the investment needs of more sophisticated investors. The instrument constituting the scheme is always available for review by potential investors prior to investing.

Unauthorised unit trusts pay tax at the basic rate on gross income (most expenses are not deductible) and are liable to tax on their capital gains. If all the investors are tax exempt (other than by reason of residence), the fund qualifies as an ‘exempt’ unauthorised unit trust and capital gains are not taxable within the fund. Also, tax exempt investors are able to reclaim the tax suffered in the fund. As such unauthorised unit trusts are efficient for tax exempt investors wishing to invest in property. As with authorised funds, stamp duty reserve tax may be payable when buying units.

13. What are offshore funds?
Offshore funds are set up in jurisdictions outside the UK and are constituted and governed by the regulator in that locality. Typically offshore property funds are resident in Jersey, Guernsey and Eire. Offshore funds that are recognised by the FSA may be sold in the UK but, in common with UK unauthorised funds, may not be marketed to the general public.

HM Revenue and Customs have no power to tax offshore funds, although UK resident investors will be assessed for tax on the returns they make from such funds, subject to anti avoidance legislation to prevent income profits being converted into capital. As there is potentially no tax at the fund level, offshore funds may be efficient for tax exempt investors wishing to invest in property. The initial transfer of property into a Jersey fund is no longer exempt from Stamp Duty Land Tax.

14. What are UCITS?
Undertakings for Collective Investments in Transferable Securities are a type of authorised fund that satisfies the rules of the European UCITS Directive and are allowed to be marketed to the general public in any EU state. The UCITS ‘brand’ is increasingly recognised globally as representing a universally appropriate investment vehicle. UCITS are not allowed to invest in direct property.

15. What is a Non-UCITS retail scheme (NURS)?
NURS have less restricted investment powers than UCITS and are able to invest in direct property. Like UCITS, borrowing by a NURS is limited to 10% of the Net Asset Value. They can be marketed to the general public.

16. What are Qualified Investor Schemes (QIS)?
A QIS has wider investment and borrowing powers than other types of authorised fund and fewer operational obligations. In particular, a QIS may borrow up to 100% of its Net Asset Value. They can be marketed only to ‘qualified investors’ as defined by the FSA.

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Liquidity and performance

17. How liquid are property funds?
Investment in property is not generally liquid due to the time it takes to buy and sell the underlying assets. Accordingly property funds must be structured in such a way so as to balance the interests of all investors. Property funds are either open-ended or closed-ended.

18. What does it mean to be closed-ended?
Closed-ended funds are created with a fixed number of units and usually have a fixed lifespan. Although there is a developing secondary market that allows the transfer of units between investors on a matched bargain basis, investors do not have the right to demand redemption of their units so may not be able to realise their investment until the end of a fund’s life

19. What does it mean to be open-ended?
Units are issued and cancelled in open-ended funds in response to investor demand. Significantly investors have the right, subject to predetermined redemption procedures, to redeem their investment at any time the fund is open for dealing*. In order to protect the interests of ongoing investors, redemptions requiring the sale of properties in adverse market conditions may be subject to deferral.

* Authorised funds are generally open for dealing every day. Unauthorised funds may have less frequent dealing days, typically monthly or quarterly.

20. How does the performance of property funds compare with direct property holdings?
Whilst past performance is not a guide to future performance, the annualised performance of property funds has been comparable with the performance of directly held property.

21. Who makes a secondary market in property fund units?
The managers of the individual funds operate a matched bargain service to facilitate bargains between buyers and sellers. In addition, HSBC operate a bargain service. Authorised funds do not operate secondary markets. Instead, units are issued or cancelled on any dealing day according to demand.

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Issues

22. Recent years have seen the emergence of new property investment vehicles such as REITs. How do property funds compare with other tax efficient vehicles?
Unauthorised unit trusts and offshore funds have been the closest offering to a truly tax effective property investment vehicle. However, since the establishment of the Real Estate Investment Trusts (REIT) regime in 2006 the Government has responded to calls to establish a versatile tax competitive collective investment vehicle in the UK. In June 2008 the Property Authorised Investment Fund rules came into force creating a single tax efficient onshore vehicle suitable for all types of investor.

23. What impact has the growth of new property derivatives had on the market?
There has been no discernible impact to date. The Association welcomes the development of other property investment vehicles and synthetics as these are likely to encourage wider investment in property, and could provide a useful source of liquidity for property funds.

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Understanding Commercial Property Investment: A Guide

This report by the Investment Property Forum was originally created to provide an information source for Financial Advisors on property investment vehicles targeted at private investors. However, since its launch in 2003, its appeal has been much wider and it has become a valuable reference document for the market. More than 10,000 copies are currently in circulation. The information in the Guide includes:

• A description of the commercial property market, in terms of size, main property types and key players, together with the mechanics of the market in terms of ownership structures, the transaction process, value adding activities, valuation and performance measurement;
• The key issues that financial advisers should be aware of when considering the suitability of a commercial property investment product for a client;
• The attributes of commercial property as an investment and the ways in which individual investors can gain exposure to the asset class;
• The risks associated with commercial property investment so that financial advisers are better placed to inform their clients about the nature of the risk they may be taking on.

Please click here to download the revised 2007 version of the Guide

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