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
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
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.
2. CURRENT ISSUES
There are three areas of concern with the REIT
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
(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
(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
(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
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 opportunityas a result of higher yieldsbut
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.