Can you save taxes with Direct Real Estate Funds?

Taxes on funds and ETFs

First, we should recap what taxes we usually pay on funds and ETFs.

In Switzerland, the main tax we pay for ETFs is the income tax. While dividends are taxed as income, this system ensures a fair distribution of wealth. It’s important to note that while this may make dividends seem less efficient than in other countries, it also contributes to a stable and prosperous economy.

The second tax we will pay is the wealth tax. Switzerland has a wealth tax based on our taxable net worth. This is generally a small amount, but it is taxed every year so that it can become significant, especially in retirement.

The final tax is the capital gains tax. Most investors do not have to worry about that because capital gains are generally tax-free. I say generally because only professional investors will pay capital gains tax.

Direct vs Indirect Real Estate Funds

A real estate fund has two possibilities for ownership of the real estate assets:

• Direct Ownership: The fund itself owns the assets.
• Indirect Ownership: The fund shareholders own the assets indirectly, and the fund manages them.

From a practical standpoint, it makes no difference to investors. The investors can still buy them the same way, and they will be accounted for similarly.

However, from a tax standpoint, it makes a lot of difference. Indeed, a direct real estate fund will be taxed directly, while an indirect real estate fund will pass all the taxes to the shareholder.

This means that you are not liable for any taxes on a direct real estate fund:

• No taxes on distributions (dividends for real estate).
• No wealth tax (taxable wealth is zero on these funds).
• No capital gains tax.

This is not tax evasion, since the fund itself was taxed. So, the fund manager company will pay taxes on the distributions. This will be reflected in the distributions and total performance fund.

Choose Direct or indirect?

So, if both are taxed but on different parts, does it make any difference?

Yes! It all depends on whether you are taxed more than a business.

The fund company itself will be taxed at around 15%. This can vary from canton to canton, but this is Switzerland’s average corporate tax rate.

As an individual, you will pay income tax based on your marginal tax rate. And your wealth tax will depend heavily on your canton and your situation.

So, there are two situations where a direct real estate fund would be better:

• If you pay significant wealth tax, since the direct version would be wealth-tax-free.
• If you have a high marginal tax rate, since the fund distributions would be income-tax-free.

Since this depends on your taxes, it will vary between investors. Investors in low-tax cantons may not have to care much, but investors in high-tax cantons may be truly interested in switching to direct funds.

It is also important to note that some funds have mixed ownerships. This means they own some properties directly and some properties indirectly. As a result, some distributions will be taxed, and others will not.

How to choose a real estate fund?

You must choose the fund after deciding whether you want a direct or indirect real estate fund. As mentioned, there are many of these funds in Switzerland.

There are three main categories of real estate funds:

• Residential
• Commercial
• Mixed

Since I prefer broad investing, I would select a Mixed real estate fund. But I think a Residential fund also makes a lot of sense. These days, I am not sure if I would invest in Commercial real estate at all.

I would also consider the diversification of these funds. Some will be invested only in a region of Switzerland, while others will be invested in the entire country. If possible, I would pick a well-diversified fund.

Even before the fees, I would also consider the size of the funds. A small fund will not be very stable and safe. I recommend a fund of at least one billion CHF in market capitalization. I found funds from about 100 million to almost 10 billion CHF, so there are significant variations.

After the market cap, we should look at the fees. These funds are not cheap. I have found funds with TER from 0.50% to 1.50%. I would personally eliminate anything higher than 1%. But this is a category of investments where we will pay significantly more than for a good index ETF.

There is another interesting metric for real estate funds: the agio. The agio is the difference between the market price and the net asset value of the fund (based on its properties). Usually, these funds trade a premium, the agio. For instance, an agio of 10% means that the fund trades at 10% more value than the properties it owns. Sometimes, the fund could be traded at a discount called a disagio.

I am not sure if I would use this metric to choose a fund, but it is definitely interesting to look at. This is one metric that is quite different from metrics on ETFs.

We can look at some concrete examples. One interesting indirect real estate fund is the UBS Swiss SIMA fund. It is a mixed fund with both residential and commercial properties. It has 9.6 billion CHF (the largest I could find) in market capitalization. Its TER is 0.90%, which is about average for these funds. And its agio (premium) is 29.1%.

For the direct real estate funds, I found the CS Ref Living Plus. It is a residential-only fund, as I could not find an excellent direct mixed real estate fund. Its market cap is 2.9 billion CHF. Its TER is 0.65%, among the cheapest. Finally, its agio is 25.6%, which places it among the most expensive funds.

These two funds are only ideas. If you are looking for real estate funds, I recommend you do your due diligence, which is essential in investing.

What about ETFs?

Unfortunately, this distinction does not exist for Exchange Traded Funds (ETFs). There are no direct real estate ETFs for Switzerland. This is likely explained by the fact that the ETF is traded directly on the stock market and not limited to a bank.

This fact also likely explains why few real estate ETFs exist in Switzerland. On the other hand, many real estate funds are available (I have counted more than 40).

Conclusion

Knowing about direct and indirect ownership is important if you want to invest in real estate funds. This can significantly affect your taxes and how you choose a fund.

Even though I am not investing in real estate funds, I find this interesting. Before researching this subject, I did not know you could get tax-free distributions from these funds.

If you are interested in real estate, there are other ways to invest in real estate. In the future, we may purchase a property to rent it. But we have not yet decided. Real estate funds are also interesting, but I wish there were more ETFs in that market.

What about you? What do you think about these direct or indirect funds?

Recommended reading

• More articles about Alternative Investments
• More articles about Investing
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• Is indirect amortization really better for you?
• 5 Simple Ways to Invest in Real Estate in 2024