Insights / 28 August 2020
Is the Professional Investor Fund (PIF) the key to ‘levelling-up’ the UK property industry?
In a speech delivered at the end of June, UK Prime Minister Boris Johnson laid out his plan to ‘level up’ the country’s economy in the wake of the coronavirus pandemic. At the centre of this plan lay the real estate sector, and the now-famous ‘build, build, build’ slogan. The Professional Investor Fund – or PIF – could be instrumental in realising this ambition.
Simon Todd, Group Head of Real Estate Services, discusses the PIF and its potential benefits for investors further.
In the March budget, the government announced that they will be initiating a review of the UK’s current funds regime, covering all relevant aspects of fiscal and regulatory structures. This was in no small part due to the efforts of the Investment Association (IA) and the Association of Real Estate Funds (AREF), who have been jointly lobbying for the establishment of a new onshore fund structure for professional investors looking for a closed-ended or hybrid vehicle to hold real estate investments.
Previously, there has not been an abundance of availabilities for structures such as this. Numerous recent high-profile open-ended fund suspensions and closures have left investors incredibly – and justifiably - wary of liquidity mismatches. This is an issue which rose to extreme prominence following the Brexit referendum, as investor outflows hit unprecedented levels, and which has again been making headlines due to the coronavirus pandemic; global funds network Calastone estimate that investors redeemed $3.1bn from mutual funds in March this year, almost three times as much as in the previous worst month of June 2016.
For institutional investors, there are open-ended solutions designed specifically for them which offer more infrequent liquidity than retail funds, alleviating to some extent the consequences of en masse withdrawals. However, even these still operate under an obligation to meet redemption requests when presented with them, which can cause distractions for the portfolio managers. Additionally, they are required to hold often very large cash reserves in order to deliver on these redemptions when they are requested, which can lead to a diminishment of returns.
Closed-ended funds provide an effective solution to this, as capital cannot be added to or removed from the fund, ensuring that managers never encounter issues with outflows. This in turn sharply reduces the frequency and necessity of compulsory asset selloffs. However, REITs are not without their flaws; due to them being listed on stock exchanges, they’re exposed to market trends and volatility. The initiation of the UK’s national lockdown provided a stark example of this, with the UK REIT price index witnessing a 38% month-on-month drop, and with a majority of REITs heavily discounted against their NAVs.
Unattractive tax structures are another flaw within many UK products, pertinently demonstrated by the fact that around 40% of total assets invested in UK property are held in offshore funds, according to Property Funds Research. This is in no small part due to the tax efficiencies enjoyed offshore; tax exempt investors in the UK, such as pension funds, typically pay very little tax on income and capital gains when their real estate investments are held by them directly, and therefore require the incentivisation of equivalence when holding them indirectly.
These reasons lie behind the proposal for the creation of the PIF, with its tax benefits being among its most compelling features. It is proposed that the PIF will not be its own legal entity so it won’t be taxed directly, with the burden instead falling on the investors themselves in a transparent, attractive structure. Capital gains, for example, will be levied upon the disposal of units which the investor holds in the PIF, and not on the gains achieved from the portfolio. What’s more, as it’s a transparent structure, non-UK investors will not be held to double taxation conventions, provided the investors’ jurisdiction recognises this transparency. This should go quite some way in attracting much-needed foreign investment into the PIF structure, and ultimately into the UK real estate sector.
In addition to all of this, the lead author of the IA paper proposing the PIF structure recently wrote about the compelling stamp duty benefits which come with the PIF, explaining that it would be exempt from transaction tax and stamp duty land tax applied on the purchase or sale of PIF units which hold UK real estate. The paper is also hopeful that the UK government will take the PIF into consideration when reviewing the VAT treatment of fund management fees – a policy which was also announced in the Spring budget. Should this occur, it would compound the numerous other tax benefits which have been discussed and make the PIF a remarkably attractive vehicle from a fiscal standpoint.
The PIF, therefore, would go a long way in addressing the lack of viable, appealing and accessible onshore property funds. As it stands, investors looking to get exposure to the UK real estate market have a choice between open-ended funds, onshore and offshore REITs. None of these, however, are without their flaws, as in the UK there does not yet exist a closed-ended, tax transparent, unlisted vehicle with units capable of being traded. The PIF would be the first of its kind, and there’s no doubt it would attract considerable attention from both domestic and international investors alike.
It is important to note at this point that many other jurisdictions offer similar Professional Investor Funds; Malta, for example, offers a highly attractive PIF structure for a number of different asset classes besides real estate, including private equity and venture capital.
If the UK adopted a similar structure to this, then the benefits of the PIF wouldn’t only be available to large institutional pension funds, but to wealth managers, family offices and sophisticated investors alike, across a diverse range of asset classes. While the proposal set out by the IA and the AREF does not discuss or specify barriers to entry – as no doubt this is a job for the treasury review which is currently underway - it does acknowledge the viability of the structure for other asset classes.
This would certainly play a vital role in bolstering the UK fund industry’s presence on the global stage – an issue which is of particular importance following our departure from the European Union. However, it is necessary to point out that the treasury, whilst having committed to reviewing and exploring the proposal put forward by the IA and the AREF, has by no means accepted it yet. However, if and when this occurs, and the UK sees the launch of its first PIF, there’s no doubt that it will be a big step towards the ‘levelling up’ which the Prime Minster spoke so determinedly about.