The great thing about doing business in the UK is the availability of structures to promote investment. The UK provides many options around efficient tax and investment planning. One such area that we at Sapphire Capital Partners LLP work with is the Real Estate Investment Trust, also known as the UK REIT.
REITs have been around in the UK since January 2007. They were brought in primarily to get equity financing flowing into the then ailing UK property market and have remained in operation since. The rules have been amended over the past few years to become further conducive to investment.
As a result of the Finance Act 2012 there were a number of significant changes - the most important of which was that a REIT could be admitted into the AIM market, thus reducing listing costs when compared to the main stock market (for a further explanation see our previous blog article Real Estate Investment Trusts - Old Dog - New Tricks?).
A UK REIT comprises of a company which carries on a property investment business in which properties are let to tenants. UK REITs benefit from an exemption from UK tax on both rental income and gains relating to their property investment business. On an ongoing basis, the REIT business has to meet certain tests as well as being 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 requirements to qualify for REIT status include tests such as those listed below.
REIT setup requirements - the balance of assets test:
- At least 75% of the UK REITs gross assets must be used in the rental business and at least 75% of the UK REITs profits must be earned in its qualifying rental business.
- Members of a UK REIT may have other activities. Such activities must not involve more than 25% of the UK REITs gross assets, nor generate profits of more than 25%. Such tests are carried out using the consolidated group results as set out in financial statements produced using International Financial Reporting Standards (IFRS) with adjustments for non-recurring or distortive items, e.g. movement on hedging, one-off transactions.
- Only rental profits and gains realised on the disposal of properties used in the UK property rental business will be exempt from tax.
- There must be at least three properties with no one property accounting for more than 40% of the value of the REIT assets (note, a single property which is multi-tenanted such as a shopping centre will count as more than one asset).
- Property development by the UK REIT for investment on its own account is permitted, and is generally included within the property rental business unless development costs exceed 30% of the acquisition cost (or the property’s value at the time of entry to the REIT regime if higher) and the property is sold within three years of completion.
- Property trading is permitted but is taxable, and falls outside of the property rental business for the purpose of the balance of business restrictions.
- There are no restrictions on foreign assets, may invest outside the UK in real estate wherever located.
The main reason why REITs are so attractive is because there is tax relief on rental income and gains from property investment. Other positive features include REITs being open to non-resident investors. As REITs are listed on exchanges, they are considered transparent and liquid investments which are positive characteristics for all types of investors. REITs combine the transparency of equities with the solidity of property investments. This is a winning combination. Institutions such as banks find REITs attractive as they reduce exposure on the banks' property portfolio by floating property on the exchanges. Others such as social housing providers have a new channel to raise capital by putting their portfolio into a REIT and reinvesting the monies raised in their housing stock. The list of institutions that benefit greatly from this structure continues to include property companies, house builders, offshore properties and institutional investors. It should also be noted that REITs can also be found in the investment portfolios of child trust funds and many ISAs.
The next logical question is who can avail of the REITs structure? There are a number of criteria that need to be met in order to become a REIT. There are capital, financing, current listing requirements, asset, income and activity tests that need to be undergone, as well as distribution requirements, all of which are outlined in our latest ebook "The Entrepreneurs Guide to Real Estate Investment Trusts".
To date, according to the British Property Federation there are circa 30 UK REITs listed in the UK with market capitalisation of circa £33 billion. Most of the properties are in the UK but a few are located in Europe. We believe that the number of UK REITs is only going to grow. Sapphire Capital Partners LLP has worked closely on a number of REITs over the past few years and have a close working relationship with the London Stock Exchange. We would be happy to discuss REITs further with you, so please contact us for an informal chat.