Investing in Property funds - PAIF? Feeders? Bid-offer

Imnoexpert_2

I am getting myself confused despite reading about it and wonder if someone can sort me out please?

Thinking about investing in L&G UK Property Feeder. For 5 years or probably more.

I invest in it outside an ISA or Sipp and my wife (through a financial adviser) invests both ISA and Sipp money into it. We are both basic rate taxpayers.

L&G Property is a PAIF and there are tax advantages for someone holding it in a SIPP or ISA - but the feeder fund which we are invested in doesn't get that benefit. (If I read correctly).

I think property funds were automatically converted to feeder funds when they became PAIFs (If I remember rightly)

I notice also that there is a bid offer spread (the reason for which I think I understand - being due to the upfront costs of the fund buying property).

So the question is - Is this an appropriate way to invest in the sector or the fund both inside and outside ISAs and SIPPs?

Thanks

bowlhead99

Some sort of bid offer spread is usual in property funds - because property is inherently illiquid and if you decide you want to take your £100 out they are not going to sell off twenty bricks from a shopping centre to get you your money, and similarly if they buy a property with contributions from you and other new investors they have large legal costs and stamp duties to pay etc. So they wish to discourage you dipping in and out as if it was a liquid fund full of cash and instantly-sellable shares.

If a fund like that doesn't have a visible bid offer spread and operates a single-priced NAV model they will just 'swing' that published price to bid basis or offer basis depending on the direction of net cash flows from time to time to reflect the cost of dealing with subscriptions or redemptions - it's the only way to be fair to the remaining (non-trading) investors in the product.

A PAIF is a special funds structure used in property, introduced a few years back, which - like a real estate investment trust (REIT) - can operate on a tax free basis and distribute income which has been "streamed" from the source of the income in different categories (e.g. interest income, net property rental income, or just normal corporate dividends) on the basis that its underlying investors will be responsible for the taxes when the income gets into their own hands.

The fact that there has been no tax leakage is useful for investors such as pension schemes, non-profit tax-exempts, ISA managers and so on who are not usually liable for tax and do not want to suffer any within the collective investment vehicle that holds the property portfolio. By having the investment vehicle be a PAIF, they are as close as they can be to being a direct investor in the underlying property.

By contrast if they just used a standard unit trust, the UT would pay tax on its profits from the property income before distributing those net profits as dividend income to the investors.

So, using a PAIF is sensible if you are a pension fund or SIPP or ISA manager who can take the distributions with no deductions at source and no further tax to pay. You are right that within a few years of the new regime being available, plenty of property funds converted to PAIFs.

However, to accommodate investors who don't qualify to get tax free distributions and pay no tax on them... or to allow distribution to investors via some fund platforms who are not set up to properly deal with streamed income sources, only "normal" dividends and interest... they have created a unit trust feeder structure through which investor monies can be collected together and 'fed' into the fund.

The feeder would pay corporate taxation on its property income but could then distribute the leftover money as normal corporate dividend to its investors. If you invest in the feeder you can then take advantage of your personal dividend allowance and low taxes on dividends generally. Rather than paying tax on the property income at your normal income rates (eg 40 or 45% for people with big incomes).

Generally if you are investing on a tax free basis (eg through ISA or SIPP) you should choose to invest in the PAIF directly rather than feeder, to save tax leakage. You may not be able to do that if your platform doesn't support it. Which might explain an IFA still using the feeder within an ISA or SIPP if the PAIF isn't supported on the platform or there s a big bid offer spread to move product. If your wife can't access the PAIF properly for her ISA/SIPP, the tax implication is often not that big (eg of the 3-4% income from the fund, only a portion of that is "property income" to be taxed at corporate rates, and the property funds will only be a small part of your portfolio, so the overall tax cost may not warrant a change to a more expensive but more modern platform that carries the PAIF).

If you invest outside of a tax wrapper it's relatively normal to just use the feeder. But check it works for your circumstances.