Memorandum by the Royal Institution of
Chartered Surveyors (RICS)
RICS (Royal Institution of Chartered Surveyors)
is the mark of property professionalism worldwide. It covers all
aspects of property, construction and associated environmental
issues. RICS has 86,000 chartered members (FRICS and MRICS)
and 55,000 members in other categories of membership (TechRICS,
trainees and students) globally. It represents, regulates and
promotes the work of these property professionals throughout 146 countries.
RICS is governed by a Royal Charter approved by Parliament which
requires it to act in the public interest. It is also a professional
regulatory body approved by Government (HM Treasury).
Overview of the REITs Regime
In December 2007 the Property Industry
Alliance of which RICS is a member, published an analysis of the
impact of REITs. This document argued that the launch of REITs
in the UK represented a very positive step forward for the UK
property industry, which will bring long term benefits to the
Market conditions will have reduced the potential
impact that REITs could have had on the commercial property industry.
It would be considered by many that REITs were introduced at the
top of the market cycle and the commercial property market has
continued to decline since then. These conditions have meant that
share prices of REITs will almost certainly have fallen and it
seems unfair to judge the success of the legislation against this
To help ensure the success of REITs they must
continue to evolve and grow. The Government must work with the
property industry to ensure that all companies that would be appropriate
to become REITs are able to do so. Legislation will need to change
to ensure that smaller companies are able to take advantage of
the REIT mechanism. There is also the area of residential REITs
which should help the creation of a dedicated build to let sector
and boost overall housing supply.
Finance Bill Issues
The 2009 Budget made some positive but
largely technical changes to UK REITs without taking significant
action to increase the use of REITs within either the commercial
or residential property sectors.
Anti avoidance measures
The key change was the introduction of anti-avoidance
provisions which will prevent restructuring within groups enabling
companies to meet the conditions to join the REIT regime. These
provisions are a welcome improvement and mean that owner occupied
properties are excluded from the tax exempt business of the REIT.
This anti-avoidance measure targets groups which
are essentially trading groups that structure in a way that HMRC
regards as artificial to satisfy the REIT conditions on a strict
technical reading, rather than property investment groups. As
such this seems to be a positive step which will ensure REITs
are legitimate property investment vehicles rather than companies
that own property, such as hotels or supermarkets, looking for
a tax advantage.
Although requiring businesses to be fundamentally
based in property investment, the changes are unlikely to increase
significantly the number of REITs.
Convertible preference shares
Measures in the Finance Bill will allow a REIT
to raise funds by issuing convertible preference shares. This
is a welcome measure which was intended to be included within
the original REIT structure. It will allow REITs to raise funds
by offering convertible preference shares in addition to the non-voting
fixed rate preference shares which are currently allowed. This
is a positive step that will make it easier for REITs to operate
Several other minor changes have been made to
the operation of REITs which RICS believe will help the system
An accounting based definition for all
REITs (applicable to groups and single companies) will be used
to define "asset" when applying the "balance of
Where a REIT disposes of a property used
in the property rental business the funds from the disposal that
are awaiting reinvestment can be treated, for up to 24 months,
as an asset of the property rental business for the balance of
Measures have been introduced to clarify
the apportionment to be applied where the asset has been partly
used for the purposes of the property rental business and partly
for non-rental purposes.
REITS and the Credit Crunch
As well as suffering in the same way as other
companies during the credit crunch and the economic downturn,
there will be a particular set of issues that affect REITs. RICS
believe that the Government should be helping ensure the stability
of the REIT market in the current climate and at the very least
maintain it at its current size.
Under the current rules, UK REITs are required
to distribute 90% of their taxable income to shareholders in the
form of cash payments. Other countries with a REIT regime, such
as the USA, have taken steps to assist REITs during the current
economic difficulties. In the US similar rules have been changed
to allow REITs to make part of this distribution in the form of
shares. The UK Government should change REITs legislation to allow
the option of allowing stock to count towards the 90% distribution.
Deferral of distribution
The 90% distribution of taxable income currently
has to take place within 12 months of the end of a REIT's
accounting period. RICS believe that this period should be extended
to help REITs which may be facing cash flow difficulties as a
result of current economic conditions. A more sensible period
may be 24 months rather than 12 months, giving much
needed assistance to the sector.
Financing costs ratio and the interest cover
Under the current regulations governing the
financing costs ratio a REIT's gross profit (before financing
costs and capital allowances) must be at least 1.25 times
the interest payable on any debt. This interest cover test has
caused particular problems in the current economic conditions
where there have been difficulties accessing credit and banks
have changed lending arrangements. In particular there have been
difficulties with banks changing swap rates which has added extra
At a time where profits are likely to be falling
due to a declining market more REITs will run the risk of breaching
the financing costs ratio. This will lead to action by HMRC and
although the company will be able to stay in the REIT regime,
they will have to pay tax that they would otherwise not be liable
for. This simply adds an extra cost to companies that are already
in difficulty and the Government should consider amending regulations
to increase the ratio.
Further Action needed on REITs
There was no change in the Budget to the flexibility
of the system or real action to increase the use of REITs in either
commercial or residential property. There are a number of steps
the Government should consider taking if they are committed to
increasing the use of REITs as a form of property investment in
Under the current arrangements property companies
have to be listed on a recognised stock exchange before they can
become a REIT. This means that companies listed on the Alternative
Investment Market are not currently eligible for conversion. Allowing
this would increase the pool of companies which could potentially
be REITs as listing on the AIM is cheaper and more suitable for
small companies. This would be particularly important if REITs
are going to be used in the residential sector. The Government
should also consider allowing unlisted REITs, and the possibility
of owner occupier REITs in areas where this could provide greater
levels of investmentfor instance hotels.
Using REITs to encourage institutional investment
and a build to let sector
Changes should be made to the REIT regime to
encourage their use in residential investment. The Government's
response to the Barker Review of Housing Supply in 2005 stated
that the REIT regime being implemented at the time in the UK would:
encourage increased institutional and professional investment
to support the growth of new housing.
Despite this desire from the Government there are currently no
residential REITs in the UK.
The need to attract extra investment was also
highlighted by the recent Rugg Review into the private rented
sector. In their response to this review, the Government states
that more work is needed on creating the right environment for
institutional investment in new supply for specifically built
to rent properties. Alongside changes to stamp duty and the planning
system, REITS have an essential role to play in this process.
Reforms must be made to the REIT regime in order
to encourage increased levels of investment. One of the barriers
to the establishment of residential REITs is that in most cases
the yield is to small for a company to operate effectively under
the current REIT structure. To address this issue changes should
be made to the gearing restriction to accommodate lower yields
from residential property.
Any residential REIT would be more reliant on
income from sales of properties than a commercial property REIT.
As a result the gearing restriction which is imposed by the 1.25 interest
cover test is harder to satisfy then with commercial property.
This happens because the profits section of the interest cover
test only includes income profits and not capital gains from property
sales. There are three potential ways to achieve this:
Allow residential REITs to include capital
sale proceeds in the interest cover test.
Provide a lower interest cover limit
for residential REITs.
Use a loan to value restriction rather
than income restrictions.
RICS has been working as part of the Property
Industry Alliance (PIA) to encourage the Government to reform
UK REITs. Further action to encourage the entry of residential
property investment companies into the REIT regime should include
Reduce the cost of entry, including the
2% entry charge and listing costs.
Remove the requirement for all REITs
to be listed on a recognised stock exchange.
Introduce some form of tax relief or
deferral for those selling property to a REIT in exchange for
shares in the REIT.
As well as encouraging entry into the system,
changes must be made to the REIT system to accommodate the business
model of residential investment companies. Reforms must be made
Allow profits arising from portfolio
"churn" to be treated as tax-exempt income of the REIT
(provided properties are on average held for a sufficient period
accepted as indicative of property investment activity);
Allow residential REITs a notional capital
allowance deduction for the purposes of computing the profits
of which 90% is required to be distributed each period, in recognition
of the fact that capital allowances, which make the distribution
requirement easier to meet for commercial REITs, are not generally
available in the residential context.
1 Recommendation 30, P80 http://www.hm-treasury.gov.uk/media/B/E/prb05_barker_553.pdf Back