 | Clark: open up real estate marketHowever, Birmingham-based Wragge & Co recently issued a warning that they will not work unless the property industry’s concerns are addressed, and issues such as the need for REITs to be listed and their tax treatment dealt with (see [2004] Gazette, 23 September, 6).
The aim of REITs, says John Christian, head of corporate tax at national firm Pinsents, is to free funding for commercial and residential property by unlocking barriers for smaller investors and institutions; to boost housing by creating a vehicle that favours better management of let residential property; and to increase flexibility in the property market, with better liquidity and returns.
He says: ‘In this currently illiquid market, a REIT could be easily tradable, providing an investment vehicle which is attractive – and thus building a much bigger market. Greater investor interest could bring an easier flow of funds, leading to more competitive finance for development and investment.’
Simon Clark, a real estate partner at magic circle firm Linklaters, says: ‘They will open up the real estate market to a wider range of investors than can currently access them. REITs need to be customer friendly and transparent, which should work for the benefit of occupiers and investors.’
Lee Nuttall, a real estate finance and tax partner at Wragge & Co, says REITs would appeal to the same people who invest in property on the stock market. ‘Instead of buying an interest in UK real estate via listed property companies, investors buy a stake in a listed REIT,’ he says.
Chris Morris, real estate partner at City giant Freshfields Bruckhaus Deringer, says REITs would be attractive to listed property companies – if they reduce the discount to net asset value at which listed property companies trade, creating a knock-on effect of making it easier for such companies to raise finance.
He explains: ‘The reason they might reduce this discount is because they avoid gains on properties being taxed both at the vehicle level – currently the listed property company, for example – and at the investor level.’
He adds: ‘Another benefit is that they are intended to provide UK retail investors with a product which gives results close to those that such an investor would obtain by investing in commercial property. The idea is the retail investor receives a liquid, tradable share or unit which can be relatively small, rather than requiring the large amount of money it takes an individual to invest in a commercial property.’
Mr Nuttall says the Treasury has long been unpersuaded by the property industry’s lobbying for a REIT, and indeed has blocked the use of tax-efficient collective investment vehicles by institutional investors – for example, through removing tax exemptions for institutions wishing to invest in real estate via limited liability partnerships.
The Treasury changed its stance when, in her report on housing supply in the UK, Kate Barker found ‘merit’ in the government considering a vehicle to encourage increased institutional investment in the housing market.
Mr Morris says: ‘There is a fear that the UK is being left behind. There are some exceptions, but the vehicle seems to have worked elsewhere. Although this more tax-efficient vehicle appears initially to reduce the government’s tax take, it may in fact result in an increase in tax over time if it prevents vast tracts of UK properties being owned offshore.’
The first part of the Treasury’s consultation, on what form UK REITs should take, ended in July. Until the Treasury responds to that consultation, says Mr Nuttall, the shape and characteristics of a UK REIT remain nebulous.
However, he adds: ‘The initial scope of a UK REIT has been expanded. They will not be limited to housing/residential but will include commercial UK real estate investment. UK REITs will not be limited to institutional investors but are to be used as a means for retail investment.’
He says the REIT proposals are too prescriptive and the property industry has serious concerns, centred on tax and the requirement that REIT status can be attained only through a public listing.
‘The UK REIT must be tax transparent for all participants. Tax-exempt funds must be able to invest knowing their returns from REITs will be free of direct tax, just like their returns from direct investment in UK real estate.’
Mr Clark says the ‘devil will be in the detail’, but that even if the government over-legislates in terms of what can be done and in how they can be funded, and does not make the tax changes necessary, the industry will strive to make REITs work.
‘The industry won’t take a single bite at this. They will be looking at a series of things to get it launched and make it work. All the alternative vehicles don’t marry the liquidity and tax transparency that a REIT gives.’
Mr Morris says that assuming it is possible to get over commercial difficulties such as the conversion charge, there are bound to be difficult tax and regulatory issues involved in implementation.
‘The government will need to tread a very fine line between making this instrument so restrictive that nobody uses it, and creating a vehicle that is capable of being used for many purposes the government never envisaged.
‘There has been speculation as to whether, to avoid a flop, the government might liaise with property companies to ensure listed property companies will find the REIT sufficiently attractive to convert in whole or in part. This would give REITs credibility at an early stage.’
Mr Nuttall says that if the government insists on 4% stamp duty on the transfer of REIT units, there will be little incentive to invest in REITs.
‘Many investors have taken their investment vehicles offshore following the imposition of 4% stamp duty land tax on transfers of interests in limited partnerships. The lesson is clear. The REITs concept will be stillborn if stamp duty land tax is imposed on transfers of REIT units.’
Mr Nuttall also says the plan to grant REIT status only to listed REITs is a mistake. ‘The expense of obtaining and maintaining a Stock Exchange listing will have an adverse impact on investor returns.’
Mr Christian says the desire to create a ‘safe’ and easily understood vehicle – in which pensions might be invested, for example – may be a reason why many of the restrictions are being considered.
But he adds: ‘This conflicts with the industry’s need for flexibility. We have to remember the failure of housing investment trusts – a framework with many similar aims. The market conditions were not right and the yield didn’t stack up. But in any case, the conditions attached were too restrictive.’
Mr Morris says that although unit trusts are gradually being amended to provide similar features as a REIT, this is not the ideal solution.
‘The main difficulty is that these unit trusts are only really available to institutions and high net-worth investors. They also involve offshore structures which the government presumably would like to discourage,’ he says.
Mr Clark says the introduction of a UK REIT will mean changes for lawyers, affecting many legal disciplines and requiring a multi-disciplinary approach, with a need to liaise closely with other professionals such as accountants and surveyors.
Mr Morris says that if REITs take off, it will mean work for lawyers in several fields, not just property lawyers.
There will, he says, be a need to restructure existing property companies so they fit the constraints of a REIT. There will also be the listing of the REIT shares themselves on the Stock Exchange, as well as the due diligence required to describe what is being put into the REIT.
‘There will be an ongoing process of advice to the REIT so that it stays within the REIT criteria and also makes maximum use of the tax benefits which it has. So the legal work, although it will include real estate work, will also include work for fund, tax, finance and, of course, corporate lawyers.’
Lucy Trevelyan is a freelance journalist
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