UK to go in the REIT direction
For a number of reasons, UK real estate professionals are as nervous about the treasury’s pre-budget report next month as a set of expectant parents. Firstly, they hope to hear that the birth will go ahead – that the government will agree to introduce a UK Real Estate Investment Trust (REIT). Secondly, they hope the birth will come at the hoped-for time in spring 2005 and, thirdly, that they will get the beautiful baby they’ve been dreaming of.
The first worry appears to be one that can be disregarded. The Treasury appears committed to introducing some sort of tax-exempt securitised vehicle for real estate investment. Furthermore, treasury insiders suggest that the initial name for the vehicle -Property Investment Fund – which was not well received by the industry, will be dropped. The name REIT will stay.
The second fear, that the introduction of the vehicle will be delayed beyond next spring, looks more justified. A UK general election is expected next May, which could lead to the budget being delayed to the autumn. Alternatively, a slimline budget, which may omit anything other than the most crucial legislation, would come out in early spring and would not include REITs. If that happens, the industry will have to wait until spring 2006.
British Property Federation chief executive Liz Peace, who has been closely involved in the industry’s lobbying campaign, says: “Next spring seems the least likely option at the moment. Prior to a general election we are unlikely to see any ‘minor’ legislation coming through. Later next year could be the best option, as it gives us longer to persuade the treasury to make changes, if necessary. People need to remember that the treasury has never given a timetable.”
Nonetheless, most in the industry have been more relaxed about the timing, mainly because they are devoting their worrying time to the potential shape of the new vehicle. More and more commentators have begun to believe that the REIT will be over-regulated, too concerned with the UK residential market and therefore unworkable.
The shadow of housing investment trusts (HITs) lies over the whole REIT debate. HITs were introduced in the 1990s but were so heavily regulated that no-one was prepared to launch them. One UK listed property company CEO says: “I fear they will make it over-regulated and over-designed, just like HITs. No-one will bother with them.”
Ciaran Carvalho, head of real estate at law firm Dechert, says: “We’ll get something, but it ought not to be overly prescriptive. Unfortunately this government doesn’t have a strong record on not being over-prescriptive.”
The Treasury’s consultation paper on REITs caused a great deal of concern, as it raised the possibility that the structure of REITs could be restricted, suggesting for example, they should only be publicly listed and internally managed. It also suggested that all REITs might be required to invest in residential property. The government is keen for more private rented accommodation to be provided both to meet demand for new homes and to calm the housing market, which has boomed over the past 10 years.
Peace says: “I would be worried if the basis for a UK REIT was proving to the chancellor that they can solve the housing crisis. However, I do believe the Treasury has moved on in its thinking since the consultation document was published. The document represented its thinking at the time.”
A major unresolved issue is the conversion charge that will be levied on companies or funds wishing to become REITS. When the Investment Property Forum and Royal Institution of Chartered Surveyors (BPF) submitted its joint response to the treasury, they did not go into detail about the conversion charge, as the treasury would not give an idea of how much revenue it wanted to raise. Peace says: “I have made it clear to the treasury that if they get this aspect of the process wrong it will kill REITs stone dead.”
The charge is likely to be based on either capital gains tax liabilities - along the lines of the French SIIC - or a simple percentage of gross assets. The latter method would allow the government to charge offshore funds which wanted to gain REIT status.
Francis Salway, chief executive of Land Securities, the UK’s largest listed real estate company, suggests a conversion charge of 0.5-1% of gross asset value – which would ensure even treatment for all types of company and fund converting to a REIT. However, this proposal is not welcomed by managers of offshore funds.
William Hill, managing director of Schroder Property Investment Management, says: “Why should we pay property companies’ charge?” He argues that offshore unit trusts, which are already tax-exempt, only have increased liquidity to gain in moving to REIT status. “If a conversion charge based on asset value was levied, it would not bring any funds back onshore.”
Since the REIT campaign began, investment managers have taken matters into their own hands and begun to develop products which give investors the same benefits as a REIT. A number of Guernsey-domiciled property investment companies have been launched on the UK stock market. These offshore vehicles pay little or no capital gains or income tax and pay high dividend yields – up to 7% annually. They also tend to have low gearing and conservative investment policies. Duncan Owen, of Insight Investment Management, which launched the £400m (e575m) Insight Foundation in June, says the company is “a REIT in all but name”, offering the same liquidity, transparency and income distribution.
This option is now being considered by an increasing number of companies, as a direct route to REIT status, regardless of what news the PBR brings.