Last month, UK banks lookedat real estate investment trusts(REITs) as a way to cut exposure to property and property debt.
The British Property Federation (BPF) recommended the creation of mortgage REITs as a place to dumpunwanted assets. Banks, says the BPF, could transfer their loan books into mortgage REITs. In return, banks would get a share in any gains made through the listed REIT entity and/or own a stake. They would be getting this at the bottom of the market.
Peter Cosmetatos, BPF‘s finance director,has already met with UK government advisers. It is understood that both Lloyds and Royal Bank of Scotland, 40% and 70% state-owned respectively, would be first to take up such an option as they aim to offload troubled loans and unwanted real estate. Together, the two banks have a total of £97bn (€112bn)in outstanding commercial property loans RBS’s exposure to loans across Europe is well-documented.
With banks in the UK increasingly acting like property companies, the BPF sees the creation of new REITs as a solution totwo key problems:banks need recapitalising and, whether state-owned or not, would welcome the opportunity to shed debt. The property sector, meanwhile, needs de-gearing.
Whether existing REITs are to be the home for these new REITs through joint ventures for offloaded mortgages and property remains to be seen. In the case of REITs taking on mortgages, it makes sense forthe vehicles toreceive interest where they would normally receive rent.But who would buy?
The prospect of existing REITs taking loans off banks’ books does not seem likely. But both British Land and Land Securities could take distressed real estate off UK banks the two REITs are capable of either launching a joint ventures with banks or going it alone. LandSec chief executive Francis Salway last month indicated that the REIT would consider buying assets thatbanks were putting up for disposal. Such a move would be similar to the waythe US dealt with its savings and loans crisis in the late 1980s.
Theaccess to the capital that REITs have is a big draw, while the enthusiasm for stocks in such entities is evident. This year, several large UK REITs have announced rights issues. As well as British Land and LandSec, rights issues fromHammerson, Liberty, Great Portland Estates, Segro and Shaftesbury took place during the first quarter of this year. In total, more than €4.1bn (£3.6bn) has been raised by REITs through rights issues this year (see graph, right).
Motives for these rights issues varied. Most were looking to balance their books, while others were targeting new acquisitions Segro used its right issue to acquire rival firm Brixton.Some used the proceeds to build a war chest to take advantage of falling property prices.
With 21 REITs in place in the UK, those cash calls by the sector’s major players must surely be taken as evidence of both the enthusiasm for UK property and the level of investor confidence in the sector. Regarded as a liquid, less-volatile, transparent and structured vehicle, the REIT offers investors a clear picture ofthe performance of their money.
UK REITs under fire
Nevertheless, UK REITs have come under fire. A House of Lords committee on economic affairs recently criticisedthe vehicles’performance since theirinception. In June, the committee said that there were “structural defects“in the UK REIT system and criticised the lack of new REIT entrances. But the lack of new entrants couldbe expected, given that the vehicle received legislative approval in 2006, and werelaunched in 2007 atclose to the top of the market.
Also, some experts feltthat REITs were always more favourable for existing firms looking to convert than for new businesses. AIM-listed London & Stamford is preparing itself for conversion to REIT status next year. Having floated on AIM in November 2007, the company hopes by next year to have completed enough deals to qualify. Max Property may also convert, while Delek Real Estate is also expected to use a REITto park its 130 car park properties. Germanand Italian REITshave attracted less interest sincetheir respective launches in mid-2007.
France’s Société Investissement Immobilier Cotée remains Europe’s leading example of how to launch REIT structures then modify them. But theUK has so far lagged behind in the fine-tuning of the vehicle. Belgium and the Netherlands have also continued to modify their respective Société d’Investissement à Capital Fixe en Immobilierand Fiscale Beleggingsinstellingstructures.
Measures to allow existing AIM-listed companies to become REITs could help to stimulate the sector, as could the creation of non-listed REITs. Seen as a deterrent to new launches, the current 2% entrance charge for those wishing to obtain REIT status could also be spread out over time and also made interest free. That could encourage some of the less heavyweight players to convert.
However, the UK government did give the REIT regime a reprieve last month in the form of an exemption from tax penalties in the case of broken gearing restrictions and interest cover ratios.
UK REITs and the BPF had argued that falls in rental income had resulted in several companies becoming liable for the penalties despite not having increased their amountof leverage. Cosmetatos says that only REITs thathave taken on excessive debt should face penalties. The general consensus within the UK REIT sector is that rules created in a period of growth are now a handicap in a downturn. With pressure from the BPF, that situation is slowly changing.
