The Finance Bill 2009 - Economic Affairs Committee Contents

Memorandum by the British Property Federation

  Real Estate Investment Trusts (REITs): Clause 65 and Schedule 34. In this case, the FBSC will be looking not only at the clauses but also at the experience of the legislation since its introduction in 2007 and how it compares with expectations then.


  1.1  What are they? UK REITs are a tax efficient, listed, UK based vehicle for collective investment in income-producing property, designed to allow investors to make an indirect, liquid and diversified investment in real estate in a way that attracts a similar tax treatment to direct investment in real estate. REITs avoid the double taxation experienced by other listed property companies. The Exchequer receives a minimum revenue each year because REITs are obliged to distribute to shareholders at least 90% of their profits from property investment, which are taxable in the hands of shareholders.

  1.2  Introduction of UK REITs UK introduced REITs in January 2007. The consultation and stakeholder engagement that led up to that was handled very well, and the legislation is generally felt to be very good and to have been brought in very successfully.

  1.3  The PIA On the back of an informal alliance between the BPF, IPF and RICS formed to promote the establishment of REITs, the industry has now created the Property Industry Alliance, bringing together the BPF, IPF, RICS and BCO (and, more recently, the BCSC). One of its principal objectives is the further development and expansion of the REIT regime.

  1.4  Take-up Around 75% of the UK's listed property sector (some £30 billion in terms of market cap) converted to REIT status during 2007, generating substantial revenues for the Exchequer through the "entry charge". On the downside, there have been very few new REITs, and there are still no residential REITs.

  1.5  Practical experience since then The administration of the UK REIT sector by HMRC is generally felt to be very good, with constructive attitudes and relationships facilitating the remarkably smooth operation of a wholly new part of the tax system.

  1.6  Market experience since then Inevitably, the REITs have suffered from the financial crisis that began in late 2007 and from the economic crisis.

  1.7  Overall assessment The introduction of REITs in the UK was very welcome and has been a success, but the timing was unfortunate, because soon after the REITs, like everyone else, became engulfed in a financial crisis. The economic crisis and the weak occupier market is emerging as the biggest challenge, but REITs are generally well placed to weather the downturn and more importantly support the recovery.


  There are three areas of concern with the REIT legislation:

  2.1  "Snagging" items Inevitably, there have been a number of areas where the REIT legislation does not work perfectly, or where it has problematic and unintended consequences. Many of these are points of technical detail, and some are more important than others.

    (a) We have been speaking with HMRC about these "snagging" items since 2007 and have classified them by priority, whether they have policy implications, and whether they require primary or secondary legislative solutions or can be addressed through guidance. We welcome the fact that Schedule 34 Finance Bill addresses three such issues, albeit they were all relatively low priority (and uncontroversial in policy terms).

    (b) Unfortunately, one issue that we had identified as high priority and which had not been felt to have policy implications has not been addressed. That issue relates to the treatment for the purposes of the "balance of business" test of cash raised from investors or lenders for the purposes of a REIT's tax exempt business. The Government has also failed to clarify its views on issues with possible policy ramifications.

    (c) The Government is currently rewriting the REIT legislation as part of the Tax Law Rewrite project. It will be disappointing if any of those "snagging" items, most of which were identified two years ago, are carried over into the rewritten legislation, in the absence of clear policy reasons.

  2.2  Flexibility during the current crisis The REIT regime imposes tight constraints on REIT groups, some of which are particularly challenging in the current economic environment and may, if the recovery is slow, create real problems for a number of them.

    (a) Well ahead of the Budget, BPF canvassed the views of the REITs and their advisers to identify any serious problems posed by the REIT rules in the current economic environment. A number of issues were identified as urgent or as likely to become urgent within a year or so on the basis of commercially prudent scenario planning.

    (b) The most significant issues relate to the requirement that REITs distribute at least 90% of their property income annually, and the technical operation of the gearing restriction to which REITs are subject. This has become critical because REITs are the only listed vehicles required by law to distribute cash, which at a time of credit rationing by banks goes against the principles of good stewardship.

    (c) Specifically, we would like REITs to be permitted to count distributions paid in the form of new shares to count towards the mandatory distribution requirement, and/or to defer the mandatory distribution for two or three years, to give them greater flexibility to balance the competing needs to maintain the strength and value of the business and to make distributions to shareholders.

    (d) We would also like the gearing restriction to be changed. It was originally constructed to prevent REITs from taking on too much debt or using debt to extract profits in a tax free way, and breach gives rise to a tax charge. However, as currently configured, the restriction can be breached because of normal commercial matters such as fair value movements in a REIT's interest rate hedges, or because of break costs that have to be paid in connection with debt repayment. That is both unnecessary in policy terms and costly for businesses.

    (e) The BPF explained the problems that had been identified to officials, and articulated the solutions proposed, emphasising the need for swift action and the fact that they would have only minimal or temporary impact on the Exchequer. It was also made clear that all the measures proposed were either intended to be temporary reactions to current economic conditions, or compatible with the notion of REITs as low risk, high distributing vehicles for collective investment in real estate.

    (f) We were extremely disappointed that the Finance Bill contains only one peripheral measure (effectively a "snagging" issue, fixing the law permitting the issue of convertible preference shares by REITs). All our other suggestions, including the three priority measures identified above, were ignored without any satisfactory explanation.

  2.3  Strategic vision More generally, Government has so far shown an unwillingness to keep the REIT regime under active review so as to identify opportunities which might be available for expansion and development which could benefit both the property sector and the wider economy. Two particular examples are residential REITs and the role REITs might play in helping the UK emerge from the downturn.

    (a) The international experience shows that REIT regimes flourish when Governments monitor and amend them to take advantage of opportunities that can deliver benefits for investors, property users and the wider national economy. Examples are successive liberalisations in the United States starting from 1986 (prior to which the US REIT sector was fairly stagnant), and the highly activist approach of France, which has brought forward amendments on an almost annual basis, successfully supporting the growth of the French SIIC regime since its introduction.

    (b) A fundamental problem which needs to be addressed in the UK is that fact that the REIT rules as originally designed served to encourage conversion to REIT status by existing listed commercial property companies, rather than to attract new entrants, because of very high entry costs. The result is that there has been very limited growth in the sector, and many new property investment ventures for which REIT status would have made sense are likely instead to be formed using offshore structures. That would be a missed opportunity.

    (c) The recent recapitalisation of the UK REITs, raising about £3 billion of additional equity, much of it from overseas, shows how UK property can attract inward investment in scale. This demonstrates a strategic opportunity, which emerges from the current downturn. REITs could have a vital role to play in recapitalising the banking sector which is undercapitalised and overexposed to commercial and residential property. Dramatic falls in property values have left banks which saw property simply as the security for their loans with unwanted primary (effectively equity) exposure to property. Their straightforward, tax efficient structure makes REITs the ideal UK resident vehicle for making such property assets available to true equity investors again. REITs were used in that way by the United States, Japan and other countries following previous recessions. We hope that the Government will engage with the industry to explore the possibilities.

    (d) Another specific strategic opportunity for the UK is the role REITs could play in transforming the private residential rented sector through more large scale and institutional investment and more professional management. Handled correctly, it could offer an inherently flexible and liquid route to residential investment for the public (the only real option now being buy-to-let), better quality of rented property and a new market for house builders and others to build for or sell to. Recent falls in house prices present a cyclical opportunity—as a result of higher yields—but the Government has so far failed to acknowledge this opportunity or take action.

  Ultimately, there is real value in exploring what a REIT regime might be able to offer and intervening judiciously to exploit opportunities. It took the United States (who introduced REITs in 1960) a quarter of a century to see that, whereas the French (who introduced SIICs in 2003) saw it at once. We would like the UK Government to see it too and to get more excited about what REITs could offer, rather than regarding its REIT regime as set in stone and not to be tampered with.

May 2009

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