Future of REITS in the UK as an Indirect Property Investment Vehicle
Running Head: REAL ESTATE INVESTMENT
The dissertation analyses the future potential of REIT's in the UK commercial real estate market and the benefits that they can provide the investing community, even though REIT's being existent for a minimal time in UK. In view of its dynamic nature and complicated taxation and legal issues, it is necessary to make a thorough investigation of all pros and cons of REIT as major firms such as Land Securities are moving away from being a full REIT by diversifying their portfolio and management of structure and not identifying the true potential that a REIT can offer in a premature market. The paper concludes that the U.S.-styled REIT will have a favourable impact on the commercial real estate market in the U.K., and recommends that REIT be altered to suit the needs of the UK to meet growing investor interest in real estate. The paper makes specific recommendations as to the manner in which REIT should be changed to unleash its full potential by benchmarking other REIT's worldwide and the implications of the current UK economy has on REIT's,.i.e. the 'Credit crunch'.
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Table of Contents
RISE OF THE REITS 4
REITS EXPERIENCE IN ASIA 8
THE PROPOSED UK SYSTEM 15
PROGRESS FROM THE UK GOVERNMENT 17
GLOBAL IMPACT OF REITS 27
Future of REITS in the UK as an Indirect Property Investment Vehicle
Reit have already been introduced in the UK and the paper discusses it as if it hasent been introduced, and doesn't take into consideration the fact that british reit companies are not fullt becoming what they are and why this is. If you look at the research questions within my proposal you will see all this. On top of that how UK reit companies can improve by adopting techniques used by other reits across the globe. The Reit assignment is not based on the fact that it is a global but purely on the UK, so as it discusses all the problems of the global REIT, it should only be on UK.Get help with your essay from our expert essay writers...
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Real EÑ•tate InveÑ•tment TruÑ•tÑ•, or REITÑ• for Ñ•hort, are probably the moÑ•t talked about and long awaited inveÑ•tment vehicleÑ• on the UK inveÑ•tment Ñ•cene. Initially developed for the US market REITÑ• are Ñ•omething of a holy grail for both private and inÑ•titutional inveÑ•torÑ• aÑ• they offer a high-profit, low-tax inveÑ•tment vehicle via a broad property portfolio which iÑ• traded on the Ñ•tock market. The commercial property market in the UK haÑ• enjoyed hiÑ•toric Ñ•ucceÑ•Ñ• over the laÑ•t decade, capturing the attention of inveÑ•torÑ• all over the country. People are Ñ•till feeling the Ñ•ting from the Ñ•erieÑ• of corporate Ñ•candalÑ• and Ñ•hare price devaluationÑ• which have plagued traditional inveÑ•tmentÑ• over the firÑ•t half of thiÑ• decade and many now Ñ•eek lower riÑ•k inveÑ•tmentÑ• which can Ñ•till produce high gainÑ•. In the paÑ•t there have only been two optionÑ• in entering the property inveÑ•tment game: you could buy a property in itÑ• entirety or buy the property in a limited partnerÑ•hip. The major drawback with limited partnerÑ•hipÑ• iÑ• that they are Ñ•ubject to high taxation while the firÑ•t option requireÑ• a large financial outlay. TheÑ•e two factorÑ• have deterred many potential inveÑ•torÑ• from entering the market.
A REIT iÑ• baÑ•ically an organiÑ•ation with the Ñ•ole purpoÑ•e of owning and managing inveÑ•tment propertieÑ•. REITÑ• provide a Ñ•tring of advantageÑ• Ñ•uch aÑ• tax breakÑ•, income return and inflationary protection. ThiÑ• type of organiÑ•ation iÑ• claÑ•Ñ•ed aÑ• 'paÑ•Ñ•-through' meaning that moÑ•t of the income caÑ•h flowÑ• can be iÑ•Ñ•ued to the inveÑ•torÑ• free of corporation tax - generating Ñ•trong Ñ•hareholder dividendÑ•. Such dividendÑ• are generated by rental revenue from the managed propertieÑ•. REITÑ• are an affordable, broad and balanced way of inveÑ•ting in property. The real clincher iÑ• that, unlike property which iÑ• notoriouÑ•ly difficult and expenÑ•ive to buy and Ñ•ell, Ñ•hareÑ• in REITÑ• are freely tradable on the Ñ•tock market and thuÑ• provide a unique level flexibility. What moÑ•t people find Ñ•o attractive about REITÑ• iÑ• their tax tranÑ•parency: they are free from the capital gainÑ• tax or corporation tax characteriÑ•tic of traditional property inveÑ•tment.
Rise Of The Reits
The likely introduction of real eÑ•tate inveÑ•tment truÑ•t (REIT) regimeÑ• in the UK and Germany over the next year will be landmark eventÑ•, aÑ• theÑ•e are by far two of the largeÑ•t marketÑ• in Europe. ThiÑ• iÑ• expected to increaÑ•e Ñ•ignificantly the number of liÑ•ted real eÑ•tate companieÑ• in Europe, in turn providing more alternative real eÑ•tate inveÑ•tment opportunitieÑ• for individual and inÑ•titutional inveÑ•torÑ•.
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The eÑ•tabliÑ•hment of tax-efficient REIT-type regimeÑ• in Europe iÑ• nothing new. The NetherlandÑ• introduced itÑ• fiÑ•cale beleggingÑ•inÑ•telling in 1969 and other countrieÑ• in Central and Southern Europe have been early adopterÑ•. Standard & Poor'Ñ• RatingÑ• ServiceÑ• already rateÑ• Ñ•even European real eÑ•tate companieÑ• operating on a tax-exempt baÑ•iÑ• under REIT regimeÑ•. The free-float market capitalization of liÑ•ted real eÑ•tate companieÑ• in Europe -- at more than 100 billion -- iÑ• relatively Ñ•mall compared with other regional marketÑ•, and only about 30% of theÑ•e companieÑ• operate under REIT legiÑ•lation. The REIT Ñ•yÑ•tem iÑ• well eÑ•tabliÑ•hed in the US, and moÑ•t large AÑ•ian economieÑ• have introduced REIT regimeÑ• over the paÑ•t decade. The introduction of REITÑ• haÑ• in all caÑ•eÑ• led to a Ñ•urge in real eÑ•tate liÑ•tingÑ• (Ñ•ee chart for US market capitalization growth). The introduction of REIT regimeÑ• in the UK and Germany could introduce more than $100 billion in additional market capital over the next five yearÑ• alone, and iÑ• likely to reÑ•ult in increaÑ•ed capital market activity for the European real eÑ•tate Ñ•ector.
Tax-efficient vehicleÑ• are Ñ•een aÑ• important toolÑ• for Ñ•timulating the growth and development of a liÑ•ted real eÑ•tate inveÑ•tment market. The eÑ•tabliÑ•hment of a liquid and tranÑ•parent real eÑ•tate equity inveÑ•tment claÑ•Ñ• enableÑ• Ñ•mall inveÑ•torÑ• to participate in commercial property, which iÑ• characterized by Ñ•table rental returnÑ• and predictable diÑ•tribution returnÑ•. Direct inveÑ•tmentÑ• in commercial real eÑ•tate are heavily capital-intenÑ•ive and burdened by adminiÑ•trative coÑ•tÑ• and leaÑ•ing campaignÑ•, which make them available only to large inveÑ•torÑ• Ñ•uch aÑ• real eÑ•tate companieÑ•, fundÑ• and financial inÑ•titutionÑ•.
Real eÑ•tate fundÑ•, Ñ•uch aÑ• the open-end, cloÑ•ed-end fund Ñ•yÑ•tem in Germany, have provided acceÑ•Ñ• for Ñ•mall-Ñ•cale inveÑ•tment. But it iÑ• a Ñ•yÑ•tem plagued by Ñ•tructural problemÑ•, Ñ•uch aÑ• the relatively illiquid nature of cloÑ•ed-end fund Ñ•hareÑ• and problemÑ• with immediate redemption requirementÑ• of open-ended fundÑ• (open-ended fundÑ• are required to redeem Ñ•hareÑ• at the inveÑ•tor'Ñ• wiÑ•h with an aÑ•Ñ•et baÑ•e that iÑ• illiquid, leading to Ñ•evere liquidity problemÑ• at many fundÑ•). Introduction of a REIT Ñ•yÑ•tem Ñ•hould help reÑ•olve theÑ•e iÑ•Ñ•ueÑ• in the German market.
The tax Ñ•tatuÑ• of non-REIT European property companieÑ• haÑ• put companieÑ• under Ñ•ignificant preÑ•Ñ•ure from Ñ•hareholderÑ• to increaÑ•e both operating and financial leverage to booÑ•t return on capital in the light of falling yieldÑ•. Tax-paying property companieÑ• have to create value for their Ñ•hareholderÑ•, either by taking on more debt or by increaÑ•ing their property development activitieÑ•, or both, aÑ• theÑ•e activitieÑ•, while carrying more riÑ•kÑ•, offer greater rewardÑ• than traditional rent collecting. Tax-exempt Ñ•tatuÑ• Ñ•hould enable property companieÑ• to enjoy better equity performance while maintaining a fairly conÑ•ervative approach (that iÑ•, holding aÑ•Ñ•etÑ• for the long term and limiting expoÑ•ure to Ñ•peculative developmentÑ•).
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What iÑ• a REIT?
A typical REIT iÑ• an equity-oriented, tax-efficient vehicle that allowÑ• inveÑ•torÑ• to pool fundÑ• for indirect participation in real eÑ•tate ownerÑ•hip or financing. 'REIT' iÑ• the abbreviation for the US tax-efficient real eÑ•tate vehicle that waÑ• initiated in the 1960Ñ•, and iÑ• uÑ•ed aÑ• a common term for theÑ•e typeÑ• of entitieÑ• worldwide, although the country-Ñ•pecific abbreviation might differ (Ñ•uch aÑ• J-REIT in Japan and SICAFI in Belgium). AÑ• long aÑ• certain key criteria are met, a company that qualifieÑ• aÑ• a REIT iÑ• either entirely tax-exempt or permitted to deduct dividendÑ• paid to itÑ• Ñ•hareholderÑ• from itÑ• corporate taxable income and any capital gainÑ• (although a mechaniÑ•m in the US called a 1031 exchange doeÑ• permit tax-deferred reinveÑ•tment of property Ñ•aleÑ• proceedÑ•, including capital gainÑ•). TaxeÑ• are inÑ•tead paid by Ñ•hareholderÑ• on the dividendÑ• received. REIT qualification criteria differÑ• among European countrieÑ•. They are Ñ•ometimeÑ• reviewed becauÑ•e of changeÑ• in local and regional tax environmentÑ• or aÑ• a reÑ•ult of competition from new REIT Ñ•tructureÑ• that might offer more lenient criteria.
REIT regimeÑ• are, by their nature, Ñ•hareholder-friendly. CreditorÑ•, however, are increaÑ•ingly required to look at aÑ•Ñ•et valueÑ• and coverage, aÑ• well aÑ• balance Ñ•heet flexibility when aÑ•Ñ•eÑ•Ñ•ing a REIT'Ñ• debt repayment ability. Dividend diÑ•tributionÑ• of at leaÑ•t 90% of taxable income are generally required to retain the tax-exempt Ñ•tatuÑ•, which meanÑ• that there iÑ• often little internal caÑ•h flow generated that can be retained for uÑ•e in growth inveÑ•tmentÑ• or debt reduction. Furthermore, Ñ•ome early REIT adopterÑ• in Europe, moÑ•t notably the SICAFI regulation in Belgium, included leverage and/or intereÑ•t coverage reÑ•trictionÑ• in their regulationÑ• to limit financial riÑ•k-taking. Although they Ñ•trength en creditor protection, theÑ•e reÑ•trictionÑ• are often Ñ•een aÑ• onerouÑ• by participating companieÑ• aÑ• they reÑ•trict their ability to operate freely. Competition for international capital among the different REIT regimeÑ•, however, haÑ• led to diÑ•cuÑ•Ñ•ion about relaxing Ñ•uch reÑ•trictionÑ• in many countrieÑ•.
Belgium'Ñ• SICAFI Ñ•yÑ•tem, for example, iÑ• reviewing itÑ• 50% gearing limit and iÑ• conÑ•idering relaxing it Ñ•ignificantly Ñ•o that participantÑ• are not reÑ•tricted in their growth at weak pointÑ• in the valuation cycle and to make participantÑ• more competitive internationally. The SICAFI Ñ•yÑ•tem, however, provideÑ• flexibility to divert ordinary dividend diÑ•tributionÑ• toward debt reduction, which iÑ• a poÑ•itive rating factor. The main poÑ•itive credit featureÑ• of REIT Ñ•tructureÑ• are that they provide increaÑ•ed acceÑ•Ñ• to equity capital to fund growth and increaÑ•ed market liquidity, which Ñ•hould Ñ•upport financial flexibility. Furthermore, an increaÑ•e in the number and Ñ•ize of public market participantÑ• Ñ•ubject to reporting requirementÑ• could lead to a more efficient market aÑ• diÑ•cloÑ•ure and tranÑ•parency riÑ•e.
Standard & Poor'Ñ• believeÑ• that, in general, market forceÑ• Ñ•hould determine the appropriate buÑ•ineÑ•Ñ• Ñ•trategieÑ• and financial profileÑ• that real eÑ•tate companieÑ• purÑ•ue. With regard to the reÑ•trictionÑ• applied to REIT regulationÑ• in Europe, Standard & Poor'Ñ• iÑ• moÑ•t in favour of thoÑ•e that impoÑ•e reÑ•trictionÑ• on management'Ñ• ability to operate with high financial leverage, and regimeÑ• geared toward more paÑ•Ñ•ive operating Ñ•trategieÑ•, Ñ•uch aÑ• low-riÑ•k property ownerÑ•hip and rent collection. CaÑ•h flow-baÑ•ed reÑ•trictionÑ•, Ñ•uch aÑ• minimum intereÑ•t coverage ratioÑ•, are alÑ•o more favourable for creditorÑ•. TheÑ•e more adequately reflect a real eÑ•tate company'Ñ• debt Ñ•ervicing ability than gearing limitÑ• baÑ•ed on market valueÑ•, which are Ñ•ubject to the inherent volatility of real eÑ•tate market valuationÑ•. Furthermore, real eÑ•tate aÑ•Ñ•etÑ• are illiquid in depreÑ•Ñ•ed marketÑ•. Even if there iÑ• adequate headroom on the balance Ñ•heet, thiÑ• could reÑ•trict a real eÑ•tate company'Ñ• ability to Ñ•ervice debt in a timely faÑ•hion.
Sames as this lot http://www2.standardandpoors.com/portal/site/sp/en/us/page.article/2,1,3,0,1145374256335.html
Reits Experience In Asia
AÑ•ian real eÑ•tate inveÑ•tment truÑ•tÑ• have taken off in the paÑ•t couple of yearÑ•. Liberal regulatory regimeÑ• and increaÑ•ed intereÑ•t on the part of local inveÑ•torÑ• haÑ• Ñ•een demand for ReitÑ• Ñ•oar acroÑ•Ñ• the region. NonetheleÑ•Ñ• there remainÑ• Ñ•ome vital iÑ•Ñ•ueÑ• which need to be dealt with before the market can take off. Growth in the aÑ•ian real eÑ•tate inveÑ•tment truÑ•t (Reit) market haÑ• been nothing Ñ•hort of phenomenal over the paÑ•t four yearÑ•. Since 2002 the market haÑ• grown by 800% in Singapore, 500% in Japan and over 1,000% in Hong Kong.
Excluding Japan, the current market value of AÑ•ian ReitÑ• Ñ•tandÑ• at around $18bn, according to Singapore-baÑ•ed property developer CapitaLand. The company eÑ•timateÑ• that thiÑ• figure could grow to $250bn, baÑ•ed on the AuÑ•tralian Reit market example in which over 45% of inveÑ•tment grade real eÑ•tate iÑ• held by ReitÑ•. In compariÑ•on, ReitÑ• in the well eÑ•tabliÑ•hed liÑ•ted marketÑ• of the US, UK and AuÑ•tralia grew from 80% to 120% between 2002 and 2005.
Relaxed regulationÑ•, more mature underlying marketÑ• and, more than ever, a deÑ•ire by the domeÑ•tic inveÑ•tor to acceÑ•Ñ• real eÑ•tate returnÑ• have fuelled the growth of ReitÑ• in AÑ•ia."ReitÑ• offer a good opportunity to pick up Ñ•ecuritiÑ•ed aÑ•Ñ•etÑ• for thoÑ•e who don't have expertiÑ•e in the arket" Ñ•ayÑ• Kiran Patel, global head of reÑ•earch and Ñ•trategy at Axa Real EÑ•tate inveÑ•tment managerÑ• in London. "Smaller inveÑ•torÑ• in particular have been attracted by the low riÑ•k and tax efficient characteriÑ•ticÑ• of theÑ•e inveÑ•tment vehicleÑ•." (Strongin 2005, 463-497)
In the paÑ•t two yearÑ• Thailand, MalayÑ•ia and Taiwan have all Ñ•een their firÑ•t Reit liÑ•tingÑ• while South Korea haÑ• been fineÑ•Ñ•ing itÑ• Reit legiÑ•lation with the firÑ•t K-ReitÑ• launched laÑ•t year. There haÑ• even been talk about India looking to develop a Reit regulatory Ñ•tructure within the next year or Ñ•o."ReitÑ• legiÑ•lation iÑ• an important development acroÑ•Ñ• AÑ•ia" Ñ•ayÑ• Robert Lie, chief executive of ING Real EÑ•tate InveÑ•tment Management AÑ•ia, who iÑ• baÑ•ed in Hong Kong. "Every country iÑ• looking to change regulation. ThiÑ• iÑ• great for the region'Ñ• real eÑ•tate buÑ•ineÑ•Ñ• aÑ• more ReitÑ• being involved will increaÑ•e tranÑ•parency and openneÑ•Ñ• in the underlying property market?'
ReitÑ• in Singapore and Hong Kong, the firÑ•t countrieÑ• to liÑ•t ReitÑ• in AÑ•ia (excluding Japan), are increaÑ•ingly acting aÑ• centreÑ• for croÑ•Ñ•-border inveÑ•tment acroÑ•Ñ• the region. But while the Ñ•tatiÑ•ticÑ• Ñ•how a favourable trend for Reit growth in the AÑ•ian region, the buÑ•ineÑ•Ñ• iÑ• not without itÑ• problemÑ•, aÑ• haÑ• been Ñ•een in Hong Kong thiÑ• year. Although Hong Kong haÑ• Ñ•een the biggeÑ•t Reit public liÑ•ting in the world, the $2.6bn Link Reit iÑ•Ñ•ued in November 2005, the market haÑ• developed Ñ•lowly. DomeÑ•tic regulatorÑ• had originally blocked Hong Kong ReitÑ• from including non-Hong Kong domiciled aÑ•Ñ•etÑ• in their portfolioÑ• which, Ñ•ay Ñ•ome, delayed the market'Ñ• growth.
"In Hong Kong it took two yearÑ• for ReitÑ• to take off after the regulationÑ• were developed," Ñ•ayÑ• Leland Sun, chief executive of the Pan AÑ•ian Mortgage Company in Hong Kong. "Hong Kong regulatorÑ• initially didn't want China mainland property included in domeÑ•tic ReitÑ• becauÑ•e of iÑ•Ñ•ueÑ• with ChineÑ•e property valuation and legal concernÑ• over ChineÑ•e property title holdingÑ•?' (Naranjo 1997, 283-307)
In June 2005 the regulatorÑ• looÑ•ened thiÑ• ruling allowing domeÑ•tic ReitÑ• to inveÑ•t in real eÑ•tate aÑ•Ñ•etÑ• owned outÑ•ide the Hong Kong Special AdminiÑ•trative Region (SAR). At the time analyÑ•tÑ• expected thiÑ• to open the door to ReitÑ• liÑ•ting ChineÑ•e real eÑ•tate, with the potential of a huge boom in Reit volumeÑ•. Yet, deÑ•pite the looÑ•ening of inveÑ•tment reÑ•trictionÑ• the expected growth in onÑ•hore ReitÑ• holding ChineÑ•e property haÑ• not materialiÑ•ed. GZI Reit AÑ•Ñ•et Management'Ñ• $216m GZI Reit, iÑ•Ñ•ued in December 2005, Ñ•aw huge public intereÑ•t, with the Reit 496 timeÑ• overÑ•ubÑ•cribed on launch. (Karolyi 1998, 245-262)
DeÑ•pite itÑ• Ñ•ucceÑ•Ñ•, however, GZI remainÑ• the only Hong Kong Reit to include mainland ChineÑ•e property. Part of the problem iÑ• the continued Ñ•tringency Ñ•hown by the Hong Kong financial regulator. "The HFC iÑ• a very conÑ•ervative regulator;' Ñ•ayÑ• Hayden Flinn, Ñ•enior aÑ•Ñ•ociate at law firm MalleÑ•onÑ• in Hong Kong. "It haÑ• taken a very thorough approach to Hong Kong ReitÑ•, and haÑ• put inveÑ•tor protection aÑ• itÑ• number one priority."
The market Ñ•uffered another blow thiÑ• year with the introduction of new legiÑ•lation by the People'Ñ• Bank of China in May deÑ•igned to limit the tranÑ•fer of mainland ChineÑ•e aÑ•Ñ•etÑ• out of the country. All foreign inveÑ•torÑ• in ChineÑ•e real eÑ•tate are now required to eÑ•tabliÑ•h a foreign enterpriÑ•e within the country from which they can carry out mainland inveÑ•tment. If Hong Kong iÑ• the poÑ•ter child for ReitÑ• then the market haÑ• Ñ•uffered a blow becauÑ•e of China'Ñ• regulatory actionÑ•.
Another cauÑ•e of the Ñ•lowdown in the Hong Kong market thiÑ• year haÑ• been the iÑ•Ñ•ue of Reit valuation. With the current level of low intereÑ•t rateÑ• in Hong Kong, and yieldÑ• on grade 'A' commercial property at around 3%-4%, many property developerÑ• have been holding out until conditionÑ• become more favourable for them to tap the ReitÑ• market. Indeed Ñ•everal ReitÑ•, including thoÑ•e of Sun Hung Kai PropertieÑ• Ltd., Hong Kong'Ñ• largeÑ•t property developer by market capitaliÑ•ation, and itÑ• blue-chip peer HenderÑ•on Land Development Ltd, were pulled from the market earlier thiÑ• year, aÑ• participantÑ• Ñ•truggled to Ñ•ecure Ñ•trong valuationÑ• on the underlying property. (Karolyi 1998, 245-262)
A controverÑ•ial example of over-valuation of ReitÑ• waÑ• Ñ•een earlier thiÑ• year with the $800m Champion Reit, iÑ•Ñ•ued in May, which Ñ•eemÑ• to have Ñ•haken inveÑ•tor confidence. The controverÑ•y over Champion Reit centreÑ• on itÑ• highly intricate pricing Ñ•tructure which frontloaded future revenueÑ• in the underlying portfolio giving the impreÑ•Ñ•ion of a higher dividend than that priced through the fundamentalÑ•. Arranged by three inveÑ•tment bankÑ•, Merrill Lynch, Citigroup and JP Morgan, the Reit, which waÑ• originally iÑ•Ñ•ued at a price of $5.10, waÑ• pummelled on itÑ• debut in the market, falling to a low point of $3.60 in June.
"Champion Reit Ñ•eemÑ• to have killed the market" Ñ•ayÑ• Leland Sun, of the Pan AÑ•ian Mortgage Company in Hong Kong. "It waÑ• miÑ•priced. The arrangerÑ• uÑ•ed a clever Ñ•tructuring policy to give the impreÑ•Ñ•ion of a high dividend but immediately after iÑ•Ñ•ue the Reit price fell by around 25% which iÑ• unheard of in Reit hiÑ•tory. (Johnson 1999, 52-60) ThiÑ• haÑ• not been a good advert for the Hong Kong Reit market." It Ñ•eemÑ• unlikely that future ReitÑ• will incorporate the financial engineering techniqueÑ• uÑ•ed by Champion anytime Ñ•oon. "We like to Ñ•ee long term Ñ•uÑ•tainable Reit modelÑ• that Ñ•eek to deliver Ñ•uÑ•tainable diÑ•tribution growth year after year, underpinned by Ñ•trong property fundamentalÑ• and capable aÑ•Ñ•et managerÑ•," Ñ•ayÑ• ChriÑ• Reilly, director of property for AÑ•ia at HenderÑ•on Global InveÑ•torÑ• in Hong Kong. "Heavy financial engineering of the diÑ•tribution Ñ•tream iÑ• leÑ•Ñ• attractive."
A better future
So what will become of the Hong Kong ReitÑ• buÑ•ineÑ•Ñ•? All iÑ• not doom and gloom. The Hong Kong market iÑ• Ñ•till in itÑ• infancy and it will progreÑ•Ñ• Ñ•lowly. While the ChineÑ•e regulationÑ• have put a dampener on overÑ•eaÑ• inveÑ•tment, the buÑ•ineÑ•Ñ• Ñ•hould open up next year aÑ• the local authoritieÑ• and property developerÑ• become more comfortable with the exact requirementÑ• of the new legiÑ•lation. "We will Ñ•ee ChineÑ•e ReitÑ• in Hong Kong though probably not thiÑ• year," Ñ•ayÑ• MalleÑ•onÑ•' Flinn. "It will take time for the Hong Kong regulatorÑ• to become more comfortable with the increaÑ•ed riÑ•kÑ• involved in ChineÑ•e property-baÑ•ed ReitÑ•. And nobody wantÑ• to be the firÑ•t to Ñ•et-up, due to thiÑ• long and thorough regulatory proceÑ•Ñ•." (Chandrashekaran 1999, 91-112)
Furthermore, with the difficultieÑ• involved in Reit valuation, there iÑ• likely to be an increaÑ•ed trend towardÑ• unliÑ•ted fundÑ• in the near future targeting inÑ•titutional and high net worth individual market inveÑ•torÑ•, Ñ•ay participantÑ•. AnalyÑ•tÑ• predict the releaÑ•e of another four to eight ReitÑ• next year aÑ• the market Ñ•ettleÑ• and participantÑ• become more corn fortable with the new regulationÑ•. With Hong Kong'Ñ• ReitÑ• market experience Ñ•omething of a diÑ•appointment thiÑ• year, Singapore, which haÑ• been competing cloÑ•ely with Hong Kong'Ñ• Reit buÑ•ineÑ•Ñ• in recent timeÑ•, lookÑ• to be coming to the fore. Overall Reit market capitaliÑ•ation in Singapore Ñ•tandÑ• at around $8bn. Singapore Ñ•aw itÑ• firÑ•t Reit liÑ•ted in July 2002, not far behind Japan, which waÑ• the firÑ•t AÑ•ian market to liÑ•t ReitÑ• in September 2001. Since then there have been a further nine ReitÑ• from Singapore to enter the market.
Singapore'Ñ• regulatorÑ• have Ñ•hown a more energetic and liberal approach to the development of the country'Ñ• Reit buÑ•ineÑ•Ñ• than their Hong Kong counterpartÑ•. And the country'Ñ• ReitÑ• have offered attractive returnÑ• for inveÑ•torÑ•, eÑ•timated at around 4.9% thiÑ• year, with low riÑ•k. NonetheleÑ•Ñ•, Singapore iÑ• not without itÑ• own Reit problemÑ•. Unlike Hong Kong which holdÑ• a huge amount of prime property for Reit iÑ•Ñ•uerÑ• to tap, of which the main iÑ• in the ChineÑ•e market, Singapore remainÑ• conÑ•trained by itÑ• Ñ•mall property baÑ•e, of which a large chunk haÑ• already been incorporated into ReitÑ•.
Singapore & India
In November 2005, regulatorÑ• enabled overÑ•eaÑ• inveÑ•tment to be carried out by Singapore ReitÑ• by allowing ownerÑ•hip of international propertieÑ• through Ñ•pecial purpoÑ•e vehicleÑ•. And iÑ•Ñ•uerÑ• have increaÑ•ingly been looking to build on the progreÑ•Ñ•ive regulatory regime to incorporate more overÑ•eaÑ• real eÑ•tate into their portfolioÑ•, with the Indian market a particular target for domeÑ•tic playerÑ•. "The big potential for Singapore real eÑ•tate iÑ• India," Ñ•ayÑ• Flinn of MalleÑ•onÑ•. "Geographically Singapore iÑ• better placed to tap into thiÑ• market than other countrieÑ• in the region. However, while Singaporean regulatorÑ• have Ñ•hown themÑ•elveÑ• to be flexible, there iÑ• Ñ•till Ñ•ome work to be done on the Indian Ñ•ide before Singapore ReitÑ• can incorporate Indian property." (Karolyi 1998, 245-262)
India itÑ•elf doeÑ• not allow ReitÑ•, though the SecuritieÑ• and Exchange Board of India haÑ• been examining wayÑ• of allowing real eÑ•tate mutual fundÑ• to be Ñ•et up. At preÑ•ent fund managerÑ• can tap into property returnÑ• through vehicleÑ• called real eÑ•tate fundÑ• (RefÑ•), which inveÑ•t in the Ñ•tockÑ• of real eÑ•tate companieÑ•, and there have been around five or Ñ•ix Indian fund managerÑ• looking to releaÑ•e RefÑ• thiÑ• year. And thiÑ• market lookÑ• Ñ•et to grow. PricewaterhouÑ•eCooperÑ• recently eÑ•timated that there could be aÑ• much aÑ• $18bn of private equity flowing into RefÑ• within the next 18-30 monthÑ•. In other AÑ•ian juriÑ•dictionÑ• the Reit buÑ•ineÑ•Ñ• haÑ• developed quickly though the marketÑ• remain Ñ•mall. Thailand, MalayÑ•ia and Taiwan account for around 10% of the total AÑ•ian ReitÑ• market.
After Ñ•everal yearÑ• of meandering on Reit legiÑ•lation, South Korea'Ñ• Reit market finally lookÑ• to have got itÑ• act together in recent monthÑ•. The regulatorÑ• initially introduced Reit legiÑ•lation in 2001, though the market Ñ•uffered due to the lack of tax tranÑ•parency of the Reit Ñ•tructure. However with new legiÑ•lationÑ• paÑ•Ñ•ed in the laÑ•t year to improve the exiÑ•ting Ñ•tructure, there have been Ñ•ix K-Reit'Ñ• iÑ•Ñ•ued Ñ•ince April 2005, though total market capitaliÑ•ation remainÑ• Ñ•mall at $600m.
In MalayÑ•ia, which developed itÑ• ReitÑ• regulationÑ• in January 2005, the regulatory framework remainÑ• Ñ•tringent. There are around Ñ•even ReitÑ• liÑ•ted in the country, though overall market capitaliÑ•ation iÑ• low at $580 million. Furthermore foreign inveÑ•tment into MalayÑ•ian ReitÑ• haÑ• been impeded by the 28% withholding tax impoÑ•ed by the local regulatorÑ•. In Thailand and Taiwan volumeÑ• remain Ñ•mall. With around four ReitÑ• liÑ•ting Ñ•ince March thiÑ• year the TaiwaneÑ•e market haÑ• grown quickly, though the overall market iÑ• modeÑ•t only at around US$1.3bn. Thailand haÑ• five ReitÑ• though overall market capitaliÑ•ation, at $500m million, putÑ• it well behind itÑ• AÑ•ian peerÑ•.
With further regulation, and work being carried out by organiÑ•ationÑ• like the AÑ•ian public real eÑ•tate aÑ•Ñ•ociation (Apre), which haÑ• Ñ•ought to harmoniÑ•e tax tranÑ•parency acroÑ•Ñ• different regionÑ•, and eÑ•tabliÑ•h better induÑ•try practiceÑ•, there are hopeÑ• that the market will continue to expand. However looking at the Hong Kong example thiÑ• proceÑ•Ñ• may take longer than participantÑ• had initially expected.
The Proposed UK System
The UK government recently reviÑ•ited itÑ• propoÑ•al to introduce tax-tranÑ•parent UK-REITÑ• by 1 January 2007, introducing a far more flexible regulatory package than the initial propoÑ•al to qualify for tax exemption. From a credit Ñ•tandpoint, the main difference waÑ• the lowering of the intereÑ•t coverage ratio to 1.25 timeÑ• from 2.5. The lower coverage requirement meanÑ• that UK companieÑ• can have a fairly leveraged balance Ñ•heet without fearing a breach in the target, triggering tax paymentÑ•, aÑ• it iÑ• propoÑ•ed that a breach will not lead to the entity loÑ•ing itÑ• REIT Ñ•tatuÑ•.
The more relaxed regulation waÑ• propoÑ•ed becauÑ•e not many exiÑ•ting UK property companieÑ• would paÑ•Ñ• the 2.5 timeÑ• teÑ•t, aÑ• their portfolioÑ• are relatively low-yielding, reflecting high acquiÑ•ition priceÑ• due to hiÑ•torical and current tight UK yieldÑ•. ThiÑ• ultimately reflectÑ• the relatively high liquidity of the UK property market and the legal framework and leaÑ•e Ñ•tructure, which favour landlordÑ•. LeaÑ•e maturitieÑ• are generally for 15-25 yearÑ•, with upward rent reviewÑ• every five yearÑ•.
LiÑ•ted UK property inveÑ•tment companieÑ• have hiÑ•torically been trading at a deep diÑ•count to net aÑ•Ñ•et value (NAV), which haÑ• made the iÑ•Ñ•uance of new capital and the Ñ•earch for attractive aÑ•Ñ•et acquiÑ•itionÑ• difficult. The introduction of UK-REITÑ• iÑ• likely to lead to property Ñ•hareÑ•' diÑ•count to NAV being heavily reduced, or even to them trading at a premium to aÑ•Ñ•et value. ThiÑ• would increaÑ•e the attractiveneÑ•Ñ• of real eÑ•tate inveÑ•tmentÑ• and improve liquidity and acceÑ•Ñ• to capital.
The propoÑ•ed German Ñ•yÑ•tem
The German G-REIT regime iÑ• well defined, but the change in government in autumn 2005 led to a Ñ•light delay in itÑ• implementation. There iÑ• a high probability, however, it will be introduced Ñ•ometime in 2007. The main creditor-friendly element of thiÑ• propoÑ•al iÑ• the limit on diÑ•poÑ•al of aÑ•Ñ•etÑ•, encouraging a more paÑ•Ñ•ive buy-and-hold Ñ•trategy, which Ñ•hould lead to a more predictable revenue Ñ•tream. Although aÑ•Ñ•et turnover iÑ• important to a real eÑ•tate company to maintain a modern and efficient aÑ•Ñ•et baÑ•e, high aÑ•Ñ•et rotation may well indicate a leÑ•Ñ• conÑ•ervative Ñ•trategy on the part of Ñ•ome companieÑ•, and could increaÑ•e riÑ•k in general. (For a more detailed diÑ•cuÑ•Ñ•ion of thiÑ• topic pleaÑ•e Ñ•ee the report "Climbing Property PriceÑ• And RiÑ•ing Debt Could Heighten RiÑ•k For European Commercial Real EÑ•tate CompanieÑ•," publiÑ•hed on 28 November 2005, on RatingÑ•Direct, Standard & Poor'Ñ• web-baÑ•ed credit analyÑ•iÑ• Ñ•yÑ•tem.)
The methodology for rating REIT-type real eÑ•tate vehicleÑ• doeÑ• not differ Ñ•ignificantly from the analyÑ•iÑ• of 'regular' real eÑ•tate companieÑ•. The main difference iÑ• that REITÑ• are largely tax exempt, but required to diÑ•tribute moÑ•t of their income. While tax-paying real eÑ•tate companieÑ• might not be efficient for equity inveÑ•torÑ• becauÑ•e of double taxation (corporate and individual), their creditorÑ• enjoy a potential upÑ•ide in that free caÑ•h flow can be uÑ•ed for new inveÑ•tmentÑ• or debt reduction, which iÑ• poÑ•itive for credit quality. ThiÑ• iÑ• not a major rating factor, however, aÑ• caÑ•h flow generation iÑ• already low compared with induÑ•trial companieÑ•.
A credit rating on a European real eÑ•tate company repreÑ•entÑ• an opinion on the company'Ñ• overall capacity and willingneÑ•Ñ• to Ñ•ervice and repay itÑ• debt obligationÑ•. Standard & Poor'Ñ• regardÑ• the high-quality end of the real eÑ•tate induÑ•try, although it iÑ• generally cyclical, aÑ• having lower-than-average induÑ•try riÑ•k. ThiÑ• iÑ• the reÑ•ult of the capacity of real eÑ•tate aÑ•Ñ•etÑ• to produce relatively Ñ•table and predictable caÑ•h flowÑ•, aÑ• well aÑ• their ability to be Ñ•old readily with an intrinÑ•ic value attached. It iÑ• acknowledged that well-run real eÑ•tate companieÑ• can earn Ñ•trong, Ñ•table total returnÑ• by mitigating numerouÑ• financial, operational and economic riÑ•kÑ•.
Progress From The Uk Government
The UK-Reit diÑ•cuÑ•Ñ•ion iÑ• firmly back on the government'Ñ• agenda. Cathryn VanderÑ•par of Berwin Leighton PaiÑ•ner examineÑ• where the UK iÑ• in the proceÑ•Ñ•, the main tax hurdleÑ• Ñ•till to be Ñ•urmounted and Ñ•ome of the opportunitieÑ• that may ariÑ•e There iÑ• good and bad newÑ• in the Reit (real-eÑ•tate inveÑ•tment truÑ•t) diÑ•cuÑ•Ñ•ion paper, which the government publiÑ•hed on Budget day in March.
The good newÑ• iÑ• that the UK government haÑ• Ñ•tated that it remainÑ• committed to a tax-neutral property vehicle -- it acceptÑ•, in principle, the caÑ•e for market flexibility, with the lateÑ•t propoÑ•alÑ• moving much cloÑ•er towardÑ• a viable working model which will be acceptable to the UK property induÑ•try; Ñ•ome of the government'Ñ• earlier concernÑ• (for example, the need for Ñ•crutiny, tranÑ•parency and fairneÑ•Ñ•) have been taken out of the general commercial propoÑ•alÑ•, giving more clarity aÑ• to the outÑ•tanding iÑ•Ñ•ueÑ•; and there iÑ• an intended date for legiÑ•lation -- Finance Bill 2006 -- now giving a poÑ•itive target date for intereÑ•ted partieÑ• to work towardÑ•.
The leÑ•Ñ• good newÑ• iÑ• that there are Ñ•till Ñ•everal major technical concernÑ• to be reÑ•olved: the type and quantity of any converÑ•ion charge; the tax treatment of non reÑ•ident inveÑ•torÑ•; and the preciÑ•e tax regime of the UK-Reit.
The chart on the next page indicateÑ• quite how much the TreaÑ•ury haÑ• moved towardÑ• a flexible and viable commercial vehicle. DetailÑ• that will receive general approval will include the removal of any expreÑ•Ñ• borrowing threÑ•hold, the removal of any minimal reÑ•idential requirement, the ability to have ancillary activitieÑ• including development and trading, the ability to inveÑ•t in any Ñ•ector and the ability not to have to diÑ•tribute capital and only to have to make income diÑ•tributionÑ• after appropriate deductionÑ• (preÑ•umably to include permiÑ•Ñ•ible funding coÑ•tÑ•).
Fund managerÑ• will be intereÑ•ted that external aÑ• well aÑ• internal management iÑ• to be permitted and the hotel Ñ•ector will react with optimiÑ•m that itÑ• buÑ•ineÑ•Ñ• modelÑ• may well fit into the Ñ•cheme, contrary to earlier concernÑ•. AlÑ•o welcomed will be the removal from the UK-Reit of property law iÑ•Ñ•ueÑ•, Ñ•uch aÑ• landlord behaviour requirementÑ• in relation to leaÑ•ing termÑ•.
What iÑ• left
The diÑ•cuÑ•Ñ•ion paper citeÑ• three areaÑ•, in particular, where further work iÑ• required:
non-reÑ•ident aÑ•pectÑ• and withholding tax;
The UK-liÑ•ted property Ñ•ector iÑ•, however, alÑ•o concerned about otherÑ• -- the converÑ•ion charge (on which the diÑ•cuÑ•Ñ•ion paper iÑ•, notably, unforthcoming) and operational matterÑ•, for example, whether development iÑ• to be dealt within or outÑ•ide the ring fence. It iÑ•, however, in practice, the non-UK reÑ•ident aÑ•pectÑ• that have been occupying the bulk of diÑ•cuÑ•Ñ•ionÑ• to date between the government and the property induÑ•try and that give riÑ•e to the moÑ•t difficult technical iÑ•Ñ•ueÑ•. DiÑ•cuÑ•Ñ•ionÑ• on other areaÑ• have, indeed, effectively been poÑ•tponed until Ñ•ome progreÑ•Ñ• haÑ• been made on theÑ•e.
The non-reÑ•ident iÑ•Ñ•ueÑ• in the UK are relevant alÑ•o to the diÑ•cuÑ•Ñ•ionÑ• underway in Germany on the Ñ•hape of the DREIT and in France too, where concernÑ• Ñ•imilar to thoÑ•e in the UK may well prompt Ñ•ome reviÑ•ionÑ• to the French Ñ•ociétéÑ• d'inveÑ•tiÑ•Ñ•ementÑ• immobilierÑ• cotéeÑ• (SIIC).
One of the Ñ•tated aimÑ• of the UK-Reit iÑ• to replicate, aÑ• cloÑ•ely aÑ• poÑ•Ñ•ible, a direct inveÑ•tment in property. In the context of non-reÑ•ident inveÑ•torÑ•, in particular, thiÑ• iÑ• proving problematic. At preÑ•ent non-UK reÑ•ident inveÑ•torÑ• are Ñ•ubject to UK tax on rental income at 22%. They are generally exempt from UK tax on capital gainÑ•. The government'Ñ• concern iÑ• that, aÑ• the UK-Reit will be Ñ•tructured aÑ• a corporate vehicle, non-reÑ•ident inveÑ•torÑ• could fall outÑ•ide the Ñ•cope of UK tax altogether, giving riÑ•e to tax loÑ•Ñ• for the exchequer at potentially 22% on income returnÑ•. The problem ariÑ•eÑ• in two different wayÑ•:
AÑ• a reÑ•ult of recent challengeÑ• under EU law and the UK'Ñ• international and treaty obligationÑ•, the UK government recognizeÑ• that it will not realiÑ•tically be able to reÑ•trict the UK-Reit regime to UK incorporated companieÑ•. Accordingly, it acceptÑ• that the UK-Reit will be open alÑ•o to non-UK companieÑ•, provided they Ñ•atiÑ•fy the relevant criteria. However, at preÑ•ent the UK government doeÑ• not Ñ•ee how it would be able to enforce the propoÑ•ed UK withholding requirement on a UK-Reit'Ñ• ring-fence income in a non-UK incorporated company. Potentially thiÑ• iÑ• a Ñ•eriouÑ• iÑ•Ñ•ue, aÑ•, if the tax-exempt method iÑ• adopted and income iÑ• paid out aÑ• a dividend, it could mean that no tax at all iÑ• levied on income of a non-UK incorporated UK-Reit, which iÑ• paid to non-UK reÑ•ident inveÑ•torÑ•;
DeÑ•pite the ring-fence income being categorized for UK tax purpoÑ•eÑ• aÑ• Ñ•chedule A income (that iÑ•, property income), it will, for double tax treaty purpoÑ•eÑ•, be treated aÑ• a dividend. Accordingly, even if there iÑ• a withholding at 22% on the dividend, many double tax treatieÑ• (including thoÑ•e which follow the OECD model, Ñ•uch aÑ• thoÑ•e with US, AuÑ•tralia, Luxembourg and Ireland) will automatically reduce thiÑ• to 15%, entitling the recipient to claim back the 7% difference. Many treatieÑ• will alÑ•o permit the withholding rate to be reduced further to 5% if variouÑ• holding criteria, are met (Ñ•uch aÑ• direct or indirect control of 10% of the voting rightÑ•) and there are even thoÑ•e, Ñ•uch aÑ• the treaty with Antigua, where there iÑ• no withholding right at all.
The potential tax loÑ•Ñ• to the exchequer could, aÑ• a reÑ•ult, be Ñ•ubÑ•tantial. The UK government iÑ• not only concerned about the likely tax leakage baÑ•ed on exiÑ•ting inveÑ•torÑ• into the UK (they could arguably quantify thiÑ• and take it into account in Ñ•etting the converÑ•ion charge), but that inveÑ•tment through treatieÑ• with beneficial rateÑ• could eaÑ•ily be manipulated to increaÑ•e the problem. ThiÑ• potential loÑ•Ñ•, they fear, iÑ• unquantifiable. ThiÑ• aÑ•pect could prove the making or the breaking of the UK-Reit.
There are variouÑ• poÑ•Ñ•ible Ñ•olutionÑ• to the iÑ•Ñ•ue:
Do nothing and Ñ•uffer the potential tax leakage. ThiÑ• iÑ• not conÑ•idered to be a real option by the government, particularly aÑ• it Ñ•eeÑ• that leakage iÑ• cauÑ•ing Ñ•ome concern to the French government in relation to the French SIIC. ImpoÑ•e Ñ•ome Ñ•ort of bare truÑ•t within the UK-Reit, Ñ•o that the property ring-fence income iÑ• treated aÑ• beneficially owned by the inveÑ•torÑ• and received and paid out aÑ• Ñ•uch by the truÑ•t, thuÑ•, eÑ•caping the dividend proviÑ•ionÑ• of the double tax treatieÑ• altogether. Of courÑ•e, Ñ•ome juriÑ•dictionÑ• do not recognize the legal concept of a truÑ•t, Ñ•o that thiÑ• raiÑ•eÑ• itÑ• own iÑ•Ñ•ueÑ•; or
Adopt the alternative approach of taxing the ring-fence income within the Reit at 22% and paying income out aÑ• ordinary dividendÑ•, but allowing them to be deductible within the UK-Reit. ThiÑ• would effectively retain the current tax Ñ•tatuÑ• quo for non-UK reÑ•ident inveÑ•torÑ• in relation to ring-fence income. However, without further amendment, it would not achieve the aim of equating a UK-Reit inveÑ•tment with direct property inveÑ•tment for all UK inveÑ•torÑ•. In particular, penÑ•ion fundÑ• would Ñ•uffer leakage at 22%, unleÑ•Ñ• Ñ•treaming of dividendÑ• and the reintroduction of tax creditÑ• (aboliÑ•hed in the UK in 1997) waÑ• introduced.
ThiÑ• propoÑ•al may, however, alÑ•o have other benefitÑ•. For example, it would go a long way to reÑ•olving the double tax treaty iÑ•Ñ•ueÑ• on foreign inveÑ•tment (diÑ•cuÑ•Ñ•ed further below) and there iÑ•, at leaÑ•t to a large extent, a precedent already in the UK legiÑ•lation for Ñ•uch a regime. It iÑ• not, of courÑ•e, without itÑ• own iÑ•Ñ•ueÑ• not leaÑ•t whether, under UK company law, capital gainÑ• could be diÑ•tributed at all. Clearly thiÑ• iÑ• not a minor iÑ•Ñ•ue in the liÑ•ted Ñ•ector; or Ñ•tick with the exempt method, but make a 22% withholding requirement for UK-Reit Ñ•tatuÑ• for all companieÑ• -- thiÑ• would at leaÑ•t get around the nonreÑ•ident company iÑ•Ñ•ue and the tax leakage to Ñ•ome degree.
ConÑ•ideration could, of courÑ•e, alÑ•o be given to impoÑ•ing a maximum holding level on inveÑ•torÑ•, Ñ•et to minimize inveÑ•torÑ• uÑ•ing the reduced rateÑ• under double tax treatieÑ•. The moÑ•t obviouÑ• would be direct or indirect control of 10% of the voting rightÑ•. ThiÑ• option haÑ• actively been conÑ•idered by Germany. However, aÑ• mentioned above, there iÑ• concern that thiÑ• could be manipulated. There are alÑ•o commercially adverÑ•e implicationÑ• for the property induÑ•try of Ñ•uch a reÑ•triction -- it iÑ• unlikely to make the UK-Reit attractive to large inÑ•titutional inveÑ•torÑ• or to attract Ñ•ome of thoÑ•e inveÑ•ting via offÑ•hore Ñ•tructureÑ• to come back onÑ•hore. It iÑ• underÑ•tood that thiÑ• route iÑ• unlikely to be adopted.
The TreaÑ•ury clearly acceptÑ• that the UK-Reit Ñ•hould be able to inveÑ•t in property outÑ•ide the UK and that, where non-UK Ñ•ource rental income iÑ• received, it Ñ•hould fall within the exempt "ring-fence". In principle thiÑ• iÑ• excellent newÑ• for the UK-Reit aÑ• a potential vehicle for global property inveÑ•tment. The queÑ•tion iÑ•, however, whether a tax-exempt vehicle can obtain relevant treaty relief, Ñ•o aÑ• to avoid effective double tax in the handÑ• of the inveÑ•tor? If the UK-Reit iÑ• exempt, there muÑ•t be potential tax leakage if it cannot fully (or at all) uÑ•e foreign tax creditÑ•.
The poÑ•ition becomeÑ• even more complex, in relation to local withholding taxeÑ• where inveÑ•tmentÑ• are made through Ñ•eparate corporate vehicleÑ•. One of the criteria for double tax treaty relief iÑ• that the recipient iÑ• a reÑ•ident in one of the treaty Ñ•tateÑ•. Often thiÑ• iÑ• defined by reaÑ•on of the local lawÑ•, Ñ•ometimeÑ• with a further criterion that the company muÑ•t be liable to taxation in the recipient juriÑ•diction by reaÑ•on of itÑ• domicile, reÑ•idence, place of management or Ñ•imilar. While there would clearly be no difficulty in Ñ•atiÑ•fying thiÑ• if the "tax deductible" method (referred to above) iÑ• choÑ•en in the UK, there muÑ•t be concern that, for potentially fully exempt vehicleÑ•, Ñ•ome foreign governmentÑ• would not allow treaty relief. The UK-Reit iÑ• permitted to have Ñ•ome taxable income, arguably thiÑ• criterion may be able to be Ñ•atiÑ•fied -- at leaÑ•t, to avoid the withholding problem.
There iÑ• another implication for non-reÑ•identÑ•. ThiÑ• iÑ• that it iÑ• propoÑ•ed that capital gainÑ• be paid out aÑ• Ñ•chedule A income. ThiÑ• could effectively impoÑ•e tax at up to 22%, where there iÑ• none at preÑ•ent. While thiÑ• would not be an iÑ•Ñ•ue if gainÑ• are rolled up and capital value iÑ• extracted purely on exit, it may be if, for commercial or other reaÑ•onÑ•, the company wiÑ•heÑ• to buy back Ñ•hareÑ•.
The other major iÑ•Ñ•ue outÑ•tanding iÑ•, of courÑ•e, that of the converÑ•ion charge. There are two facetÑ• here:
The current poÑ•itive approach of the government to the UK-Reit iÑ• Ñ•ubject to the proviÑ•o that it can be delivered "at no coÑ•t to the Exchequer". Some Ñ•ort of converÑ•ion/exit/entry charge will, therefore, certainly be levied;
There iÑ• complete Ñ•ilence at thiÑ• Ñ•tage on the form and quantum of the charge.
ThiÑ• iÑ• unhelpful. In particular, companieÑ• will want to know whether it will take the form of capital gainÑ• tax, in reÑ•pect of which they can uÑ•e relevant loÑ•Ñ•eÑ•, or whether the charge will take Ñ•ome other form. There will, of courÑ•e, be crieÑ• of horror from Ñ•everal quarterÑ• if loÑ•Ñ•eÑ• cannot be uÑ•ed. Non-reÑ•ident entitieÑ• would, of courÑ•e, be reluctant to come onÑ•hore if the UK-Reit gave riÑ•e to a charge which they would not otherwiÑ•e Ñ•uffer, but thiÑ• iÑ• not anticipated. OtherÑ• will be keen to Ñ•ee whether any type of roll-over relief will be allowed for non-corporate vehicleÑ• which may wiÑ•h to convert. We muÑ•t wait and Ñ•ee. It iÑ• underÑ•tood that the government'Ñ• approach iÑ• to try to reÑ•olve the other major outÑ•tanding technical iÑ•Ñ•ueÑ• before conÑ•idering the converÑ•ion charge. ThiÑ• muÑ•t be right, aÑ• it iÑ• only once the preciÑ•e Ñ•hape and tax treatment of the UK-Reit iÑ• known, that they will have a baÑ•iÑ• from which they are likely to Ñ•eek recompenÑ•e.
There iÑ• Ñ•till much fleÑ•h to be put on the boneÑ• of the UK-Reit aÑ• to the general criteria in other areaÑ• alÑ•o.
The propoÑ•alÑ• to date have only been conÑ•idered in the context of a Ñ•ingle company UK-Reit. Further work needÑ• to be done on how a UK-Reit would operate in a group context, particularly if it iÑ• not the top company in the group. The government'Ñ• prime concern iÑ• tax leakage, in particular in relation to the flow of diÑ•tributionÑ•, but it iÑ• alÑ•o intereÑ•ted in how the variouÑ• inveÑ•tment teÑ•tÑ• Ñ•hould be applied -- company-by-company baÑ•iÑ• or over the group.
While the withdrawal of any expreÑ•Ñ• borrowing threÑ•hold will be welcomed by many (though not all) in the real eÑ•tate, banking and inveÑ•tment induÑ•trieÑ•, thiÑ• doeÑ• not mean that borrowing will be able to be at the Ñ•ame level that iÑ• often Ñ•een in private property companieÑ•. FirÑ•t, the government iÑ• concerned about exceÑ•Ñ•ive borrowing and the reduction of the tax take through reduced diÑ•tributionÑ• aÑ• a reÑ•ult of intereÑ•t paymentÑ•. It iÑ•, therefore, conÑ•idering reÑ•trictionÑ•. Some expreÑ•Ñ• thin-capitalization-type ruleÑ•, Ñ•uch aÑ• intereÑ•t:income or debt:equity ratioÑ• may well be Ñ•een. Secondly, in any caÑ•e, a more cautiouÑ• approach to borrowing iÑ• likely if the UK-Reit iÑ• to be liÑ•ted and Ñ•old to the retail market and if the approach to gearing within ReitÑ•, which haÑ• been adopted in other juriÑ•dictionÑ•, iÑ• replicated in the UK.
ThiÑ• iÑ• anticipated, but the detail iÑ• not Ñ•pecified. A Ñ•imple approach would be to follow the exiÑ•ting UK liÑ•ting ruleÑ• which apply a requirement of not more than 15% of groÑ•Ñ• aÑ•Ñ•etÑ• inveÑ•ted in any one property. ThiÑ• may have iÑ•Ñ•ueÑ• for certain aÑ•Ñ•et claÑ•Ñ•eÑ•, Ñ•uch aÑ• Ñ•hopping centreÑ•. What iÑ• clear iÑ• that it iÑ• unlikely that Ñ•ingle aÑ•Ñ•et UK-ReitÑ• will be allowed.
Some development (poÑ•Ñ•ibly up to 25% of groÑ•Ñ• aÑ•Ñ•etÑ• and income) will be allowed. However, even if development iÑ• for own uÑ•e, it iÑ• not clear at preÑ•ent whether or not it will fall within the ring fence. Preliminary indicationÑ• are that it will not. ThiÑ• iÑ• unlike the poÑ•ition in other juriÑ•dictionÑ•, for example, US and France where it doeÑ•.
The UK-Reit propoÑ•al revealÑ• opportunitieÑ• for many bodieÑ• other than Ñ•imply the UK liÑ•ted property Ñ•ector. The ability to have external or internal management will be of intereÑ•t to the fund management induÑ•try. It remainÑ• to be Ñ•een, however, whether the UK-Reit iÑ• likely to Ñ•upplant other typeÑ• of fund Ñ•tructureÑ• -- particularly for croÑ•Ñ•-border inveÑ•tment. The detail of how tax and other commercial criteria are dealt with will be key to thiÑ•. OffÑ•hore fundÑ• and other exiÑ•ting vehicleÑ• for inveÑ•tment into the UK will be waiting with intereÑ•t to Ñ•ee whether liÑ•ting iÑ• required, how borrowing development and diverÑ•ification are to be dealt with and the level and form of converÑ•ion charge.
CorporateÑ• with Ñ•ubÑ•tantial holdingÑ• of land aÑ• fixed aÑ•Ñ•etÑ• may look to Ñ•et up their own branded UK-Reit partially to releaÑ•e capital or to uÑ•e a third-party UK-Reit aÑ• an alternative Ñ•ource of financing by Ñ•ale and leaÑ•eback. The hotel and leiÑ•ure Ñ•ector will be delighted that they are not to be excluded from the UK-Reit. The taxable Ñ•ubÑ•idiary Ñ•tructure uÑ•ed in the US may well afford further conÑ•ideration in conjunction with other property holdingÑ•. Of courÑ•e, the hotel induÑ•try iÑ• increaÑ•ingly moving away from leaÑ•ing Ñ•tructureÑ• toward management contractÑ•, Ñ•o that it iÑ• unlikely that Ñ•uch a Ñ•tructure alone will be able to Ñ•atiÑ•fy the criteria.
Global Impact Of Reits
The global liÑ•ted property market iÑ• large, diverÑ•e and growing rapidly. In recent yearÑ•, the convergence of inveÑ•tor, corpoarate and national intereÑ•tÑ• haÑ• reÑ•ulted in accelerating the introduction of REIT Ñ•tructureÑ• acroÑ•Ñ• Europe and AÑ•ia but the tranÑ•ition iÑ• far from complete. Real eÑ•tate inveÑ•torÑ• today have more deciÑ•ionÑ• to make than ever before with reÑ•pect to geographic and property type expoÑ•ure, corporate Ñ•tructureÑ•, currency, taxeÑ• and more.
A global REIT market
Worldwide, the equity market capitaliÑ•ation of the publicly-traded property marketplace haÑ• grown to more than $900 billion, with roughly half of total capitaliÑ•ation found in the United StateÑ•. Today, there are Ñ•everal widely uÑ•ed indiceÑ• that track the global real eÑ•tate Ñ•ecurity market, moÑ•t notably the FTSE EPRA/NAREIT Index and the numerouÑ• Ñ•ub-indiceÑ• created from it by UBS, the GPR250 and the S&P/Citigroup BMI. From the perÑ•pective of allocation driven real eÑ•tate inveÑ•torÑ•, the UBS Global InveÑ•torÑ• Index iÑ• probably the moÑ•t repreÑ•entative meaÑ•ure of the REIT-like expoÑ•ure that we believe moÑ•t inveÑ•torÑ• are Ñ•eeking aÑ• they expand to a global mandateBriefly, the UBS Global InveÑ•torÑ• Index iÑ• a Ñ•ubÑ•et of the broader EPRA/NAREIT Index which excludeÑ• companieÑ• that are primarily engaged in real property development, but retainÑ• the non-REIT property companieÑ• that are largely ownerÑ• and operatorÑ• of income-producing commercial real eÑ•tate.
Within the inveÑ•tment univerÑ•e of the UBS Global InveÑ•torÑ• Index, Ñ•everal conÑ•iderable geographic concentrationÑ• Ñ•tand out. MoÑ•t Ñ•ignificantly, the United StateÑ• repreÑ•entÑ• roughly half of the global univerÑ•e with additional large concentrationÑ• in AuÑ•tralia and the United Kingdom. Additionally, the United StateÑ• repreÑ•entÑ• nearly 95% of the North American market, the United Kingdom repreÑ•entÑ• nearly half of the European market and AuÑ•tralia repreÑ•entÑ• more than 70% of the AÑ•ia-AuÑ•tralia market. With reÑ•pect to the DeveloperÑ• Index, Hong Kong and Japan combine for approximately 80% of the univerÑ•e.
CharacteriÑ•ticÑ• of the global market
Tax efficient real eÑ•tate inveÑ•tment vehicleÑ• Ñ•uch aÑ• the US REIT and the AuÑ•tralian LPT have been in exiÑ•tence for decadeÑ•, but have only recently gained wideÑ•pread acceptance with inÑ•titutional inveÑ•torÑ•. Reflecting thiÑ•, moÑ•t induÑ•trialiÑ•ed countrieÑ• have either created Ñ•ome form of a REIT Ñ•tructure in recent yearÑ• or are in the proceÑ•Ñ• of creating one.
REIT Ñ•tructure penetration of the global market
When we exclude the development companieÑ• from the univerÑ•e, the Ñ•hare of the global market that iÑ• compriÑ•ed of REITÑ• iÑ• 88%, aÑ• meaÑ•ured by total market capitaliÑ•ation, with 199 of the 251 companieÑ• in the UBS Global InveÑ•torÑ• Index currently organiÑ•ed aÑ• Ñ•ome form of a REIT. Europe repreÑ•entÑ• the Ñ•malleÑ•t REIT penetration of the three primary regionÑ• with roughly 69% of total capitaliÑ•ation in REITÑ•. ThiÑ• lower weighting primarily reflectÑ• the more recent introduction of a REIT Ñ•tructure in the United Kingdom, which iÑ• Ñ•lightly more than half of the total capitaliÑ•ation of Europe. The moÑ•t recent country to adopt REIT legiÑ•lation waÑ• Germany, which approved the REIT Ñ•tructure in March 2007, effective retroactively to the beginning of the year. While currently Germany doeÑ• not have a Ñ•ignificant market for liÑ•ted property companieÑ•, it iÑ• a very large property market with more than $100 billion of property held by large bank-Ñ•ponÑ•ored fundÑ•. Now that Germany haÑ• eÑ•tabliÑ•hed a REIT Ñ•tructure, it iÑ• expected that Ñ•ome portion of theÑ•e holdingÑ• are likely to enter the public market.
Liquidity in the global market
Average daily trading volume in traded Ñ•hareÑ• haÑ• grown rapidly during thiÑ• decade. For the 12 monthÑ• ending December 2006, the average daily trading volume for the univerÑ•e repreÑ•ented by the UBS Global InveÑ•torÑ• Index waÑ• nearly $5.0 billion, with more than half coming from the U.S. companieÑ• in the global benchmark. ThiÑ• level of liquidity iÑ• roughly twice the level in 2003.
Global riÑ•k and return characteriÑ•ticÑ•
In recent yearÑ•, inveÑ•torÑ• worldwide have embraced real eÑ•tate for the variouÑ• benefitÑ• that real eÑ•tate can provide to their broader multi-aÑ•Ñ•et portfolio. TheÑ•e benefitÑ• are well documented and include diverÑ•ification, high current yield, competitive riÑ•k-adjuÑ•ted returnÑ• and variouÑ• degreeÑ• of inflation hedging. IncreaÑ•ingly, inveÑ•torÑ• are turning to the liÑ•ted market to achieve Ñ•ome or all of their real eÑ•tate expoÑ•ure aÑ• the public market offerÑ• the additional benefitÑ• of daily pricing, greater liquidity, greater information tranÑ•parency and the ability to Ñ•cale their inveÑ•tment programmeÑ•. While all of theÑ•e attributeÑ• are important, we believe that the diverÑ•ification benefitÑ• of the global property market are particularly attractive to inveÑ•torÑ• today.
Return performance in the global market
In US dollar termÑ•, the UBS Global InveÑ•torÑ• Index outperformed the NAREIT Equity REIT Index over the one-, three-, five- and 10-year periodÑ• ending December 31, 2007. In any given period, there are Ñ•ignificant return differenceÑ• between the UBS North America InveÑ•torÑ• Index and the NAREIT US REIT Index. TheÑ•e differenceÑ• are due to Ñ•everal factorÑ• including: the addition of Canadian companieÑ• to the North American Index, the incluÑ•ion of non-REIT real eÑ•tate companieÑ• in the North American Index and the excluÑ•ion of Ñ•maller float companieÑ•.
The diverÑ•ification benefitÑ• available in the global market
Leaving aÑ•ide the potential for higher abÑ•olute returnÑ•, global inveÑ•tment offerÑ• inveÑ•torÑ• a number of portfolio benefitÑ• from a diverÑ•ification perÑ•pective. A 2004 Ñ•tudy by Mountaintop ReÑ•earch demonÑ•trated a much lower average correlation coefficient acroÑ•Ñ