United Kingdom: Real Estate Investment Trusts

Accounting and property industry experts welcomed changes to the structure of UK real estate investment trusts (REITs), which were introduced on January 1, 2007, after then Chancellor of the Exchequer Gordon Brown"s Budget announcement in March, 2006.

Under the new structure, the charge payable to enter into the regime equalled 2% of the gross market value of the properties that transfer into a REIT - significantly lower than had been envisaged during the lengthy consultation period in the lead up to Brown"s eventual announcement.

"More listed property companies are likely to find this affordable," commented Charles Beer, Head of Real Estate at KPMG, who believed that Brown had largely heeded the concerns expressed by the industry over the Treasury"s original proposals.

“As a result of changes announced in the Budget it is now more likely that a significant number of property companies will convert to Real Estate Investment Trusts in 2007," he predicted at the time.

Another key change meant that the distribution requirement had been reduced from 95% to 90% of taxable profits and REITs were given 12 months to make the distribution, instead of the originally proposed 6 months.

Experts expressed reservations over a provision in the rules which were designed to prohibit a shareholder from owning more than a 10% stake in a REIT which Mr Beer described as a "major concern." There was also no transitional relief for existing shareholdings.

However, a company would no longer be disqualified from the regime in the event that a shareholder held 10% or more of its shares or votes. Instead, a tax charge would be levied on the company in the event that it pays a dividend to a shareholder holding 10% or more, unless the company has taken reasonable steps to avoid paying such distributions.

In other changes announced in the budget, the interest cover ratio requirement was reduced from 2.5:1 to 1.25:1, and REITs were to be permitted to issue fixed rate preference shares and convertible debt, which had previously been precluded.

“The Treasury has responded positively to a number of industry's concerns," noted Peter Beckett, Tax Director in Ernst & Young"s Real Estate Group.

"Several quoted UK property groups now seem likely to convert into REITs in 2007," he added.

Nonethless, others, such as Phil Nicklin, real estate tax partner at Deloitte, believed that the conversion charge could still discourage those who have established listed property companies offshore to come back into the UK, although he remained broadly supportive of Brown"s changes.

“The Treasury has taken on board most of the major points made by the property industry during the consultation process. The revised rules will result in a flexible regime, which makes it likely that the major listed UK property companies will convert to a REIT and that the REIT sector will get off to a good start," he observed.

In April 2006, Simon Conannon, tax partner at UK firm Walker Morris, said that the UK Listing Authority's proposed relaxation of its rules would allow smaller property companies to take advantage of the attractive new regime for REITs announced by Gordon Brown in his budget.

Said Mr Conannon at the time: "From 1 January 2007, property companies will be able to convert to Real Estate Investment Trusts (REITs) with potentially large tax benefit. Gordon Brown announced many of the details in his Budget Speech. However, following an announcement by the UK Listing Authority last week, it looks like the restrictions will be relaxed even further - allowing yet more property companies to benefit from becoming a REIT."

Mr Conannon said that the Chancellor's eagerly awaited announcement of a very low conversion charge for property companies to become REITs had already proved to be something of a financial bonanza to the listed property sector - something which can be seen in the significant increases in the share price of companies like British Land and Land Securities.

However, the potential tax giveaway looked set to become even greater as the listing rules for property companies were, as mentioned above, set to be relaxed.

Mr Conannon observed ahead of the changes that: "Currently the main restriction on companies seeking to benefit from the REITs regime is that such companies need to be listed on the stock market. This is not only costly for smaller private companies, but under existing listing rules, there are a number of restrictions which would make it practically impossible for certain smaller property investment companies to meet the requirements. These include requirements concerning the expertise of directors, a requirement that the company have net assets of at least GBP30 million, and complicated requirements concerning the composition of the portfolio.

"However, the good news is that the UK Listing Authority (UKLA), the organisation that regulates the UK stock market, has announced that it is reviewing the rules in relation to the listing of property investment companies and has removed some of these more onerous conditions.

"This review will mean that it will not only be the very large property companies which can benefit from Gordon Brown's largesse but smaller property companies, many of whom will currently be privately owned and which may in fact form part of trading groups, could benefit in the future.

"This is something that any company which owns property should consider, as it may well be worthwhile for companies which are not currently property investment companies to restructure to benefit from the new rules.

"The message is that companies need to start planning now. Even with the low conversion charge and a relaxing of the listing rules there may still be substantial restructuring required by companies to enable them to convert to REIT status.

"For example; firstly companies will need to satisfy the property condition which specifies that a REIT must hold at least three properties with no single property exceeding 40 per cent of the total value of the property assets. Note this does not prevent a REIT from holding a single asset, so long as it is not designed to be let out as a single unit. For example each lettable unit in a shopping centre is a separate property for REIT purposes.

"Secondly, to qualify as a REIT at least 75 per cent of the company's total gross income must come from rental income and at least 75 per cent, by value, of its assets must be in the form of investment property. Companies that currently carry out a mixture of trading and investment activity, may need to divest themselves of at least part of their non-property holding businesses in order to qualify.

"Finally as we mentioned earlier, REITs will also have to be listed on the Official List (a listing on the Alternative Investment Market will not suffice). Companies seeking a listing will need to appoint a sponsor and will need to prepare a prospectus. The process of obtaining a listing usually takes about three months from the first meeting with the sponsor to admission to the Official List. At least 25 per cent of the company's share will need to float freely.

"These requirements all mean that there may be significant restructuring necessary for companies to covert to a REIT. Therefore, the potential tax benefits are considerable but companies need to start planning and seeking advice now."