Why don’t Australian REIT dividends have franking credits?

Australian real estate investment trusts (A-REITs) have been carried by the decade-long property boom in Australia to deliver an investor’s holy grail of capital growth and income.

The Shopping Centres Australasia Property Group Ltd  (ASX: SCP) share price has risen 33% since October 2015 on strong retail tenancy rates and maintained its strong capitalisation rates. It’s a similar story for residential real estate REIT Mirvac Group Ltd  (ASX: MGR), with its share price soaring 47% over the same period on sustained property demand amid cheap mortgage rates and economic growth.

On the income side of the equation, Stockland Corporation Ltd  (ASX: SGP) currently yields a healthy 7.32% while Vicinity Centres Re Ltd  (ASX: VCX) offers a similar 6.28% income yield for willing investors.

But if you take a closer look, you’ll see that none of these A-REIT dividends are franked – and it’s unlikely they ever will be.

The “trust” in “real estate investment trust” is the key here. Unlike Australian companies, which pay dividends out of their after-tax profits and can attach a tax-deductible portion called “franking credits”, the trust structure of REITs means its a whole ‘nother ball game.

REITs don’t technically pay dividends, these are “distributions” which aren’t franked because the income that the REIT is actually passing onto investors isn’t taxed at the REIT level. So the way it really works is a pass-through rate from the REIT, which must pay out 90% of its earnings to shareholders in the form of distributions, therefore, it does not pay corporate tax.

So what does this mean for me?

The implications of this for investors will vary on an individual’s tax situation. For those that can use franking credits, this technicality may be the difference between investing in REITs and choosing a fully-franked dividend stock such as Alumina Ltd  (ASX: AWC).

With a Labor election victory looking likely in May, it will be interesting to see how the market reacts to the potential changes to cash refunds from franking credits for retirees. While no one can say for sure, retirees should be aware of their after-tax return implications from the changes. Particularly for those invested in those juicy fully-franked shares.

After all, an efficient tax setup can get you closer to your after-tax target return without lifting a finger.