Listed property: An attractive option for your tax-free investment portfolio

The Prudential Enhanced SA Property Tracker Fund is an option worth considering for inclusion in your tax-free portfolio.

But before we get into the “why”, let’s begin with the “what”. The Prudential Enhanced SA Property Tracker Fund was launched in December 2005 and invests in a variety of South African property instruments listed on the JSE. The fund does not hold any physical property, but rather invests in shares of listed property companies and Real Estate Investment Trusts (REITs). Unlike physical property, shares are liquid instruments, meaning that they can be easily bought and sold. For a more detailed explanation of the features of listed property, see part 3 of our Understanding Asset Classes series.

You may be wondering how the fund differs from a pure index tracker fund. Without getting technical, Prudential actively manages the fund, aiming to “enhance” returns by overweighting and underweighting shares in the benchmark (the South African Property (SAPY) Index) that the fund manager deems to be undervalued and overvalued, respectively. The objective of the fund is to match or moderately outperform the total return of the SAPY Index after fees over all meaningful time periods. By contrast, a pure index tracker fund will always underperform its benchmark (after fees), regardless of the investment period. The Prudential Enhanced SA Property Tracker Fund has a strong long-term track record among the peer funds in its ASISA category, consistently ranking in the top quartile.

So why should you consider including listed property in your tax-free portfolio?

Long-term Investment

All capital growth and income in a tax-free investment is exempt from tax. As such, the longer you remain invested in tax-free unit trusts, the greater the benefits you will realise. The Prudential Enhanced SA Property Tracker Fund is suitable for investors requiring medium to long-term capital and income growth, with a recommended investment time horizon of 5 years and longer.

Of course, before including any particular fund in your portfolio, it’s important to consult your financial adviser to ensure its suitability given your unique personal circumstances.

Attractive Outlook

Listed property has had an exceptional run in recent times, and is the highest-returning asset class in absolute terms over the past 5, 10, 20, and 30-year periods. While there’s certainly no guarantee that this stellar performance will be repeated over the next 30 years, current valuations indicate potential double-digit (i.e. inflation-beating) returns over the medium term, in the absence of a market de-rating.

Tax Saving

All JSE-listed REITs are required to pay at least 75% of taxable earnings available for distribution to investors. As such, the distribution yield of property unit trusts is typically higher than that of equity unit trusts.

Unlike equity fund distributions, which largely comprise dividends subject to 20% dividend withholding tax (DWT was increased to 20% from 1 March 2017), all REIT distributions are classified as “REIT Income” and are taxable in your hands at your marginal income tax rate. Based on the 2018 tax tables, the highest marginal tax rate will be an effective 45% from 1 March 2017. It’s also worth noting that the annual interest exemption offered by SARS may not be applied to REIT income.  

For the few listed property companies that have not adopted REIT status, a small portion of the distribution will be classified as local dividends (subject to DWT), with the remainder classified as interest that is taxable at your marginal income tax rate after your annual interest exemption of R23 800 (under 65 years of age) or R34 500 (65 years of age and older).

Given the higher distribution yield, together with the potentially higher tax rate applicable to distributions (relative to equity funds), significant tax benefits can be gained by including property unit trusts in your tax-free portfolio. In addition, any capital gains earned within the fund will be exempt from capital gains tax (CGT) when you ultimately redeem your units.

Prudential offers a range of five tax-free unit trusts to suit a variety of risk and return profiles. For more information about the benefits (and limitations) of tax-free investments, see this article by Pieter Hugo, Managing Director of Prudential Unit Trusts.