A Real Estate Investment Trust (REIT) is broadly a company that owns and operates income-producing real estate or real estate-related assets.
UK REITs are now able to offer (post-Finance Act 2012) a cost effective, tax efficient solution to the problems faced by institutions and companies with large property portfolios and liquidity issues. At least potentially, a UK REIT should be a method of raising money to assist the depressed property market. This is certainly what HM Treasury is hoping to achieve in the amendments to the Finance Act 2012. As a result, it should now be easier, in theory at least, to set up a UK REIT. However, only time will tell.
I recently discussed five particular questions pertaining to REITS in the UK with Mark Fahy of the London Stock Exchange and a number of other professionals from the world of property. The questions will follow with a explanation of the answers we jointly came up with.
Question 1: What are REITs in their current form (i.e. prior to the Finance Act 2012)?
A UK REIT consists of a group of companies carrying on a property investment business, with property let to a third party tenant. A UK REIT has the benefit of an exemption from UK tax on
both rental income yields and gains relating to its property investment business. Currently (and this is about to change, for the better), a UK REIT must pay an entry charge of 2% of its gross assets to enter the regime. On an ongoing basis, the REIT business has to meet certain tests and the REIT is required to distribute 90% of its rental income in respect of each accounting period, in order to obtain exemption from tax on its rental income. The UK REIT must be a UK tax resident and cannot be resident elsewhere, but the holding company can be foreign and it can own assets anywhere in the world.
Question 2: Why are REITs so important?
A REIT allows an investor to put an investment straight into real estate, as if the investor owned it directly. In other words, the property is held by the investor and therefore it is the investor who pays the tax in their tax return rather than the REIT (although a 20% withholding tax is levied at the REIT level). This is good for the property market as it attracts investors into the market who otherwise would not have been able to access it. HM Treasury, desperately needing to breathe new life into the residential real estate market, have in their wisdom, decided to make more REITs available to investors. They have endeavoured to do this through The Finance Act 2012, which brings us to the second part of our discussion.
Question 3: What are the changes to REITs due to the Finance Act 2012?
There are five main changes that should be highlighted:
(i) abolition of the 2% entry charge to join the regime - this should make REITs more attractive due to reduced costs;
(ii) relaxation of the listing requirements - the big news here is that REITs can now be listed on AIM (the London Stock Exchanges international market for smaller growing companies) again making a listing more attractive due to reduced costs and greater flexibility.
(iii) a REIT now has a three year grace period before having to comply with close company rules (a close company is a company under the control of five or fewer investors) - again, this allows much greater flexibility;
(iv) a REIT will not be considered to be a close company if it can be made close by the inclusion of institutional investors (authorised unit trusts, OEICs, pension schemes, insurance companies and bodies which are sovereign immune) - this makes REITs attractive to institutional investors, hopefully putting more liquidity into the REITs market.
(v) the interest cover test of 1.25 times finance costs is not as onerous. The most important of these advantages is the ability for REITs to be listed on the AIM and the abolition of the
2% entry charge to the regime is also a significant step forward.
Question 4: What are the new opportunities now presented by AIM?
Mark Fahy of the London Stock Exchange highlighted the workings of the AIM market and why it would be so attractive to REITs. With 1,143 companies with an aggregate market capital of GBP65.4 billion, and access to the worlds leading institutional investors listed on the AIM market, a new REIT listed on this market will have unparalleled access to capital. This will be at a much reduced listing cost and the REIT will be under less ongoing regulatory scrutiny than it would be with a listing on the London Stock Exchange, or another equivalent overseas stock exchange, as was required prior to the Finance Act 2012. This should breathe new life into the REIT market and in turn, bring about investment into residential property.
This is exactly what the HM Treasury hopes. More REITs means more investment in property and as a consequence, more investment in residential property.
Question 5: How can one take advantage of the new REIT regime?
Opinions were varied on this one, but the conclusion was clear. REITs will present an opportunity to breathe new life into a distressed market.We concluded that REITs could be very attractive to organisations, such as banks with an exposure to property which needs to be reduced, the property could be floated as a REIT. Banks, it was felt, will be unlikely to set up a REIT, and will alternatively wait for an approach from an existing REIT offering to put their distressed portfolio into a REIT. I have the feeling this attitude will change once new REITs start appearing and at least one bank will take advantage of the new REIT regime to get rid of its distressed property portfolio.
One big topic of discussion was social housing. Social housing providers could put some or all of their property portfolios into a REIT structure in order to raise new capital in order to provide new housing.
In fact, earlier this year, the Communities and Local Government Select Committee published a report which recommended the creation of private REITs and a pilot housing investment fund run by housing associations. The general opinion in relation to this was that although there is certainly opportunity for social housing REITs, the difficulty will be convincing the social housing providers to embrace the REIT structure.
Perhaps one of the biggest opportunities lies with property companies - to convert their existing portfolios into a REIT. It will certainly be cheaper to do so than it was previously. Offshore property companies now have the opportunity to move into a tax efficient onshore structure without high costs and HMRC scrutiny of their offshore activities.
Is this really a case of old dog (property), new tricks (REITs)? I dont think so. The new REITs regime genuinely appears to be aimed at breathing new life into a depressed property market that desperately needs the liquidity. Opportunities abound for investors in this sector, and only time will tell if significant numbers of new REITs will appear and investors take advantage of them. Lets hope so.
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Photo by Omega Man