What is a Real Estate Investment Trust/Fund (REIT)?
A REIT (Real Estate Investment Trust) is an entity designed to provide investors with the opportunity to profit from income-generating real estate investments. The acronym REIT stands for ‘Real Estate Investment Trust’ or, as referred to in the Income Tax Ordinance, ‘Real Estate Investment Fund.’ In other words, an investment fund focused on real estate.
The legislation permitting the establishment of REIT’s was enacted in 2005 (Amendment 147), introducing the REIT investment vehicle to the Income Tax Ordinance.
According to Income Tax Circular No. 2018/4, the purpose of the REIT instrument is to enable both experienced and inexperienced investors to invest in a trust dedicated entirely to income-generating real estate assets. The trust is obligated to regularly distribute all its profits to shareholders, ensuring a steady flow of returns for investors.
The financial instrument allows for the public to indirectly participate in large-scale income-generating real estate projects and enjoy the benefits of the investment. Real estate assets eligible for investments may include, industrial buildings, offices, residential buildings, commercial centers, shopping centers, and more. Additionally, investments can be diversified in terms of the amount invested, and the composition of the investment portfolios (changing risk distribution).
REITs are subject to a single-tier taxation model aligned with the principle that shareholders should be treated as though they directly invested in the income-generating real estate asset. The profits generated and distributed by the trust are taxed solely at shareholder level, and not according to the standard corporate model of double taxation- which is taxed at both corporate and shareholder levels.
Subsequently, amendment 222 to the Income Tax Ordinance, was enacted to amend and clarify the chapters provisions that govern the taxation of REITs. This has allowed for the simplification of its application and encourages establishment of additional real estate trusts.
Advantages to the Country
Low taxation on REITs could encourage the establishment of more trusts in Israel, resulting in more institutionalized and organized investment opportunities. With the right incentives for private investors, it is possible to transform the Israeli real estate market to have a preference for investing in REITs, rather than directly in real estate. Such transformation can be more efficient, economic-wise for both experienced and inexperienced investors and diminish initial intimidation for potential investors.
Types of REIT’s
There are two types of REIT’s:
Type one- REITs traded on the stock exchange.
In the framework of this type of REIT, an individual can invest in real estate projects, worth various amounts (not necessarily large ones). This trust allows the investor to manage risks in a way that suits them, as the investment is divided into a variety of projects.
Type two- REITs specializing in real estate financial funding.
This type of REIT purchases real estate through loans and mortgages from various entities. The purchased real estate serves as a collateral for the repayment of the loan.
General Overview of the Conditions a Company Must Meet to be Considered a REIT:
- The trust must be established as a new company created specifically for the purpose of a real estate trust, with no prior rights or obligations. This ensures that, after public offering, the public holding shares in the trust will not bear any past liabilities.
- The value of its income-generating assets must not fall below 200 million NIS.
- The trust must be listed for trading on the Tel Aviv Stock Exchange (TSE) in Israel. Additionally, the trust may be listed on a stock exchange abroad.
- At least 95% of the assets are income-generating real estate properties.
- The trust’s leverage ratio must not exceed 60% of the value of the income-generating real estate, and 20% of the value of the other assets.
- Development activity in the trust can not exceed 5% of the total asset value.
- At least 75% of the company’s assets must be located in Israel, based on the total value of all income-generating real estate.
- No more than five investors directly or indirectly, may hold 50% or more of the equity or voting rights in the trust.
- The trust will distribute profits as dividends amounting to at least 90% of the taxable income.
Taxation of REITs
As mentioned earlier, the investor in the REIT is treated as directly holding the funds assets (instead of the two-tier taxation model). Therefore, for tax purpose; capital gains tax, tax rates and loss offsets, taxable income, including, real estate capital gains of the trust distributed to shareholders under the conditions of section 64a9 of the Income Tax Ordinance, will be treated as if it were taxable income or real estate capital gains of the shareholders.
The idea behind this policy is “transparency”, defined in the section as ‘the taxable income of the shareholders.’ This transparency essentially replaces the two-tier tax model.
In contrast to this, losses accumulated by the trust won’t be distributed to the shareholders, rather will be carried forward to future years and will be offset solely at the trust level, in accordance to the offset provisions outlined in 64a4(h) of the Tax Income Ordinance.
The tax liability for the trust’s income occurs at the time of receiving the profits or other distributions from the trust. The tax liability for the sale of the trust’s shares will occur at the time of selling the shares.
There is a variety of tax aspects and benefits as a result of amendment 222 to the Income Tax Ordinance. For example, profits gained from the sale of real estate (capital gains tax) differs from the tax imposed on rental income. Through tax planning and professional services, like those provided in our firm, it is possible to reduce tax’s and optimize REIT investments according to the applicable conditions.
Advantages of REITs
- Risk management through amounts and investment distribution.
- REITs are required to report on assets and expected dividends.
- High profit potential in income-generating real estate.
- No extensive experience or knowledge required to invest in REITs.
Disadvantages of REITs
- Dependence on the trusts management company, not every company will yield profits.
- Dependence on the capital market, REITs involve stock investments which can be volatile.
- Limited investment scope, due to not being able to invest in non-income generating real estate assets.
Currently, there is a small number of REITs available in Israel, however, due to the state’s incentives, there may be a significant growth in the coming years. When done with the proper management and professional consultation, investing in REITs can be profitable, convenient, and safer than other market investments.
