REITs

How do you solve a problem like REITs?

After years of debate, and some of the most effective property industry lobbying in UK history, the REIT regime finally burst into our lives on 1 January 2007, only to be met with a reception that could, at best, be described as frosty. So what is the future of the UK REIT and where do the specialist REITs fit in?

A REIT is a property investment company listed on a recognised exchange (which does not currently include AIM), that, subject to fulfilling certain conditions and paying a one-off entry charge, will not be subject to any corporation tax and will have all latent capital gains wiped out.Was this Tony’s parting gift to us all? Not likely! One of the cornerstones of the Government’s philosophy in introducing the REIT regime was that the Government would suffer no loss.The tax is borne by the shareholders and this is made certain by providing that a REIT must distribute at least 90% of its profits from its investment business income as dividends.

I have not repeated the remaining conditions for REIT qualification, but it is clear that the regime in its current form certainly favours the large blue chip listed property vehicles, over the small cap and private entities. There is some logic in this, with the Government giving the ‘big boys’ a leg up so as to create a stable REIT sector and gain investor confidence, while they bed down the legislation.

So why the lacklustre performance? It is widely agreed that the UK property sector (both listed and unlisted) has experienced remarkable growth in the last three years and many have believed for some time that a correction is due.

But what of the companies that have converted? Some of these (notably British Land) have already been criticised for being too general.Their shares are now largely trading at a discount. The days of the industrial conglomerate are long gone. Investors prefer to identify industry sectors in which they wish to invest and management that they wish to invest in. It begs the question as to whether the time of the property conglomerate is also over.The United States introduced a REIT regime in the 1960’s and REITs now dominate the listed property sector in the US.What is more interesting is the growth and influence of the specialist REIT in the US.There is evidence that the UK is following this trend, certainly in the property sector generally, and this is likely to be reflected in the REIT sector as it matures.There is an expectation that some of the more general UK REITs will be taken over and broken up into sector specific REITs, which tend to trade at a higher premium.

So what of the current sector specialists and why aren’t they queuing up to take advantage of the panacea offered by the REIT regime? Of course some have: Big Yellow, Primary Health Properties and Local Shopping.

What of the others? Punch has announced that the time is not right for them. Enterprise has recently highlighted the difficulty in the pub sector of the strict application of income rules. Mitchells & Butler has also declined to go the REIT route. An issue for the pub operators is that the treatment of ‘wet rent’ is still unclear. Other sectors are also being hampered by the need to define pure rental income.

As mentioned above, the REIT regime appears to be purpose- built for the large listed players, where the conversion to the REIT regime is achievable without much effort (I suspect many of the advisers involved in the conversion of the first wave REITs, who spent New Year’s Eve in their offices, would have something to say about this).

...the REIT regime appears to be purpose-built for the large listed players, where the conversion to the REIT regime is achievable without much effort...

Many of the high profile specialist property investment companies in the UK are not structured in a way to take advantage of the current REIT regime without significant restructuring and the inevitable costs involved. Many of the existing specialists are already housed in tax efficient structures such as off-shore funds and private equity structured vehicles, and see no immediate benefit in converting to REIT status.

Nevertheless the REIT regime is the most significant piece of legislation to affect the UK real estate sector for many years. There is every reason to believe that, notwithstanding the lacklustre beginnings, REITs will play a significant role in the UK real estate sector in the future.

It is disappointing that the first bespoke specialist REIT has been shelved. Vector Hospitality, owning 71 hotels including brands from Hilton, Marriott, Malmaison, Hotel du Vin and De Vere, was due to launch on the UK Stock Exchange looking to raise approximately £2 billion. Although this float was beset by concerns over the management structure and jitters in the property market, I believe that others will follow. In the next 18 months or so the UK REIT sector is likely to be dominated by mid to large cap companies. This is largely due to the way the regime has been structured. Once the regime has bedded down it is likely that the Government will start to widen the ambit of the legislation, to make REITs attractive to a wider audience. It will not be a surprise in the future to see private REITs seeding relief for start-ups and bespoke REITs together with other reliefs designed to attract smaller companies and sector specialists.

Larry Nathan
Corporate Partner
larry.nathan@mishcon.com

Property Matters! 05