Insights / 04 August 2021
REITs – a force for good?
Coming into effect on 1 January 2007, the UK Real Estate Investment Trusts (REITs) regime has evolved to the point where there are now 100 UK REITs that own around $141bn (£100bn) of property investments. But what are the benefits of REITs and can they be said to be a force for good?
Crestbridge executives joined Ashurst and Cushman & Wakefield in June 2021 for a lively discussion of these points and more. Dean Hodcroft, Crestbridge Chief Executive, was joined by Crestbridge Directors Simon Todd and Ana Kekovska for the video discussion which took place live and with an audience in attendance.
Key benefits of REITs
First off, the panellists discussed the merits of the REIT structure.
- REIT brand-value: “The value of the REIT brand itself shouldn't be underestimated,” said Ana Kekovska. REITs have built a global reputation as tax efficient structures for real estate investment and many jurisdictions operate their own version of REITs or REIT-like regimes. The regime is therefore familiar to and welcomed by analysts and investors around the world.
- REITs attract local and international capital: This brand recognition goes a long way to attracting capital, Ana continued. The regime has a proven track record of this capital attraction and managers find that converting to a REIT often means attracting new sources of funding. Ana continue, “Institutional investors like investing in a REIT structure, with pension and sovereign funds in particular using the private REIT structure as their route to UK property investing.”
- Lower tax & transaction costs: Another significant benefit of the regime is that REIT status can reduce or entirely eliminate any discount to net asset value caused by latent capital gains. In a tight real estate market, REITs have a considerable competitive advantage on corporate acquisitions, as other non-REIT bidders may have to discount their bid price for the asset to account for the latent capital gains and resultant corporate tax when they themselves come to sell the asset. In short, REITs are able to bid for assets in a tax-exempt environment, giving them a considerable commercial advantage over non-REIT bidders. REITs may choose to share this benefit with the vendor, in a quid-pro-quo that reduces their own purchase price and allows the vendor to increase their post-tax proceeds.
- Simple structure: According to Ana, the relatively straight forward corporate structure of REITs is part of the attraction, especially to institutional investors overseas. “It can be less frightening than trust structures, which are generally challenging for the international market.”
- Inherent structural benefits of REITs vs owning physical real estate: The REIT structure affords considerable benefits versus holding property directly. Namely, liquidity – it is easier to access and exit the UK property market via a REIT compared to holding the underlying property itself. The purchase and sale of a property could take months or years, whereas purchasing or selling shares in a readily tradeable investment asset is clearly much faster. The acquisition cost of the shares is also much lower, at a rate of 0.5%, compared to the 5% stamp duty payable on direct property acquisitions. Holding shares in a REIT offers regular income returns versus holding property directly, as REITs must distribute 90% of its exempt rental profits to investors as a Property Income Dividend. Finally, the benefits of ownership of hard to access parts of the market, such as a shopping centres, can be enjoyed by investors in a REIT, who may otherwise be unwilling or unable to make such large commitments.
- Onshore management: There’s continued pressure on institutional investors, particularly NGOs, university endowments and pension funds, to invest in onshore, rather than offshore structures. With increased scrutiny from tax authorities on offshore structures, largely through programmes such as the Base Erosion and Profit Shifting (BEPS), REITs offer an HMRC-approved, low risk and stable platform for investors of all types.
Can REITs also be a force for good?
“ESG is no longer just three letters thrown into the end of a pitch deck” and indeed, there are very few conversations taking place between investors and managers now that don’t substantially focus on ESG.
Panellists emphasised that governments, investors and occupiers were all focusing on ESG and managers not catering to this will fall well behind the curve. At worst, assets failing to become more green and contribute to the health and mental wellbeing of occupiers could become discounted, relative to other similar properties in the market that do take ESG factors into account, according to Crestbridge’s Simon Todd.
Panellists noted several significant market trends that REITs can and increasingly will, play a large role in, showing how REITs provide both a financial and social return.
- Senior living: With the Baby Boomer generation approaching retirement age, investors are anticipating a huge increase in the demand for senior living and care provision. REITs have entered this market, some of them newly established, to take this challenge on and provide capital and expertise to care home operators. Specialist REITs such as Impact Healthcare REIT plc focus exclusively on this social issue.
- Healthcare: With an aging population also comes an increase in the demand on healthcare services. Primary healthcare facilities such as GP offices are in demand and those that exist are not fit for purpose, according to a recent survey from the British Medical Association (BMA). The survey revealed 40% of GPs believes their premises were not fit for purpose. REITs such as Assura and Primary Health Properties specialise in increasing the stock of GP surgeries.
- Social housing: Sustained shortfalls in public funding has meant housing associations having to take on ever-increasing levels of debt in order to finance new development projects and maintain existing ones. REITs specialising in this area can be effective at bridging the funding gap for those housing associations, allowing them to meet the needs of their communities without the need to take on yet more debt – and ultimately help them to build more social housing. Once again, there are specialist REITs investors can access, in order to address this pressing social issue.
How to become a REIT and maintain your REIT status
There are several conditions to satisfy in order to be classified as and to then maintain REIT status. If these conditions are breached, it could result in penalties ranging from automatic expulsion from the REIT regime altogether, to the addition of some tax liabilities for the REIT in question.
According to Crestbridge’s Ana Kekovska, the REIT Journey encompasses the following stages:
- REIT feasibility: Are the conditions of REIT met and can they be maintained?
- Conditions include: Admittance to trading on “a recognised stock exchange:” Ana notes that The International Stock Exchange (TISE) is now home to 40% of all UK REITs and listing times can be as quick as 6 weeks from initiation to listing. On the other side of the spectrum, a main-market London Stock Exchange listing could take a minimum of 6-months but is still the preferred route for public REITs.
- Not a close company: Broadly, this means not privately owned and controlled, or done so by five or fewer individual participators.
- Distribution conditions: 90% or more of its tax-exempt income profits (not capital gains) must be distributed to investors, as well as 100% of any property income distributions received from other UK REITs, within twelve months of each accounting period.
- Property rental conditions: A minimum of three properties must be held, none of which can exceed 40% of the total value of the portfolio. There are particular definitions around what qualifies as a “rental property.”
- Balance of business: At least 75% of gross assets and of accounting profits, on an IFRS basis, must be generated from the property rental business.
- Financing cost ratio: A tax penalty may arise if the REIT does not maintain a profit to financing cost ratio of 1.25:1.
- REIT conversion: Support will be required from a number of advisors, to include:
- Pre-conversion tax advice;
- Legal & structuring advice;
- Listing support;
- Accounting & prospectus;
- Capital market / capital raising strategy;
- Entity establishment.
- HMRC clearances & REIT launch: Notice in writing and clearances to be obtained. Listing the REIT entity.
- Following REIT launch: Ongoing support & advice, to include:
- Governance support;
- Monitoring & managing compliance with REIT regime, fund and listing rules;
- Financial reporting and forecasting;
- Distribution processes;
- Market announcements;
- Future transactions.
Crestbridge assists its clients throughout the REIT journey, which can be a huge undertaking for the manager. “AML requirements, applicable fund regime, market abuse regulation, listing rules – this list can be daunting. The responsibility legally falls on the board, and it's our role to put a processes in place to make this routine for the board, help them navigate the regulatory landscape and have the infrastructure in place to keep them safe, allowing them to focus on maximising value for investors,” says Ana Kekovska.
In this way, rather than getting lost in the detail of what the regulator requires, managers can find it essential to seek third-party, outsourced help. Following the successful launch of the REIT, there is also often a huge reliance on the REIT administrator to drive the routines behind maintaining the conditions to REIT status. Once again, this allows the manager to focus on the assets within the REITs portfolio and ultimately to maximise value for the shareholder.