On the REIT track - 10 years on REITs remain a strong structuring option
02 June 2017
A decade has passed since its inception, and there hasn't been a more sensible time to invest in the UK-REIT, says Ogier Group Partner Craig Cordle. With 10 years passing since the introduction of the UK-REIT, he looks at why it remains a popular choice for international investors.
The principal attraction for the UK-REIT remains the favourable tax treatment afforded by HM Revenue & Customs. It benefits from an exemption from UK corporation tax on property investment income and capital gains.
Of course, there are various conditions that must be met, but this is good news for international investors who will want to see their share of UK-REIT profits taxed in their home jurisdiction. The savings can be significant, coupled with the benefit of investing on a pooled basis and spreading investment risk between sector, type, number and geography of properties.
The conditions for qualifying have also gradually become more permissive. For example, institutional investors are now excluded from the ‘close company condition’, which means that it is now possible for a limited number of institutional investors (even one) to control UK-REITs.
In addition, for international investors, the UK-REIT may be seen as offering easier exposure to property than by way of direct investment, and providing access to types of property that such investors may not be able to access alone. UK-REITs are also required to list on a recognised stock exchange, such as the London Stock Exchange or the International Stock Exchange (TISE) in the Channel Islands, where a quarter of UK-REITs are currently listed, which means that investors benefit from the potential liquidity of owning a traded security.
Listing on a recognised exchange also gives comfort to investors that the UK-REIT is subject to a suitable level of governance and oversight.
Have they been affected by the UK's decision to leave the EU?
The strong likelihood is that the UK-REIT will not be affected significantly by the UK's decision to leave the EU. Although some overseas property investment is permitted, the UK-REIT is predominantly a UK property product and the income that can be made from UK property remains in steady demand from within the UK and internationally.
In the short term, there may be some concerns about the marketability of UK-REITs to EU investors given the restrictions under the Alternative Investment Fund Managers Directive (AIFMD), however, national private placement regimes (NPPRs) continue to work well, particularly for entities domiciled in the Channel Islands.
In fact, in relation to financial services, the third country status of Guernsey and Jersey vis-à-vis the EU is entirely clear and will be unchanged by Brexit. This is good news for the UK-REIT as the Channel Islands continue to offer certain and durable options for structuring funds and fund management operations.
Why is structuring them through the Channel Islands a sensible choice?
There are multiple reasons why structuring UK-REITs through Guernsey or Jersey makes sense, including:
- Distributions in both Guernsey and Jersey are permitted to be made on a solvency basis, meaning the process of making distributions can be more straightforward than with a UK company.
- Stamp duty is not payable on the transfer of shares in a Guernsey or Jersey company. This is one of the great attractions of Channel Islands companies. This is particularly relevant to the easy entry/exit of investors in UK-REITs, and is a positive for liquidity.
- Protected and incorporated cell companies are recognised under the laws of Guernsey and Jersey. Where ring fencing of assets and liabilities is important, the availability of these vehicles can assist greatly in structuring UK-REITs.
- If listing on TISE, UK-REITs are exempt from the free-float rule requiring 25 percent of the issued share capital to be held in public hands. The availability of this exemption may be particularly attractive to a smaller number of institutional investors investing for the long term and where liquidity is not a priority.
In addition, Guernsey and Jersey already meet the conditions set out in the AIFMD under Article 36 (being the conditions for EU managers marketing third-country funds to EU investors under NPPR) and Article 42 (being the conditions for third-country managers marketing funds to EU investors under NPPR). The Channel Islands have been operating successfully within NPPR since 2013 with cooperation agreements having been entered into with the competent authorities of 25 of the 27 EU member states (that is, all except Austria and Italy).
Guernsey and Jersey are two of only five third-countries that have, to date, been positively assessed by the European Securities and Markets Authority (ESMA) for the purposes of extending the AIFMD marketing passport. Both jurisdictions have already implemented fully compliant AIFMD regimes in anticipation of the availability of the passport, for those Guernsey or Jersey managers that wish to be prepared once a passport becomes available to them, including where a member state automatically switches off its NPPR.
Following Brexit, the timetable for the third-country passport is now unclear, however, our experience tells us that, in most cases, managers tend to market to investors in only very few EU member states. Therefore, marketing under NPPR is a straightforward and far less costly option than marketing under the AIFMD passport.
More generally, there is a wealth of expertise in the Channel Islands in the areas of portfolio and risk management, compliance and reporting, delegation and outsourcing models, and management company services. The tax system is straightforward and not subject to change and management companies are able to operate on a zero-percent corporate tax basis. In addition, UK-REIT overheads may also be lower with service providers based out of London operating in Guernsey and Jersey.
Guernsey and Jersey have led the way in adopting global best practice in transparency and anti-corruption, while maintaining confidentiality and privacy for businesses wishing to protect legitimate commercial interests. Furthermore, the Channel Islands are easily accessible from a number of UK airports, making access and attendance at board meetings very easy.
What are the main opportunities for UK REITs going forward?
Existing UK-REITs and those managers considering establishing their own UK-REIT should continue to take advantage of the UK-REIT's unique proposition for investment into UK property, especially with Brexit in mind. In addition, for the international investor with a strong home currency vis-à-vis sterling, they can continue to take advantage of an additional uplift in value when investing. Of course, if the value of the pound rises comparatively against an investor's home currency, then their returns could be reduced, assuming they wish to convert back to their home currency and absent any currency hedging that may be put in place.
What are the main obstacles?
As with many asset classes, there is always a danger that the market may become saturated with competing products and that investors' allocations to UK property may become full. This may, in time, make establishing new UK-REITs a little harder, particularly if existing larger UK-REITs remain open to new investment. It’s generally easier to grow an existing fund through secondary fundraising, rather than building a new book leading up to the initial public offering of a new UK-REIT. However, for the right investment proposition, there is plenty of dry powder and sub-sectors into which UK-REITs are yet to venture.
As noted above, currency plays an important role for the non-sterling investor and a stronger pound may gradually dampen the attractiveness of UK-REITs for the international investor. Some financial commentators have started to say that they expect to see a noticeably stronger pound by the end of 2017 and into early 2018, which may have an impact on non-sterling investors investing in UK-REITs.
The tone of the forthcoming Brexit negotiations and the terms of any exit agreement that may be reached will be important to the value of the pound. Of course, many international investors will hold sterling accounts and so currency values may be less relevant to them.
Finally, Base Erosion Profit Shifting (BEPS) Action 4, which relates to the deductibility of interest, may have an impact on the UK-REIT regime, however, the impact of the implementation of the full suite of BEPS sections on the UK-REIT (and certain investment funds generally) currently remains unclear.
An original version of this article was first published in Real Estate Investment Times, Issue 16, 18 April 2017.
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