Standard Life’s Property Income Trust and F&C’s UK Real Estate Investment Trust recently became the latest London-listed real estate funds to elect to become UK REITs.
This appears to be part of a growing trend towards REITs being the default structure for real estate investment in the UK.
The government introduced the REIT regime in 2007 to encourage the holding of real estate onshore. While a number of propcos converted in the regime’s early days (16 companies became REITs in 2007, including British Land and Land Securities, and four joined in 2008), some aspects of the regime were highly unpopular. A key drawback was the 2% “entry” charge (calculated on the gross value of the company’s rental properties) on becoming a REIT.
The REIT rules were overhauled in 2012 in an effort to encourage more new REITs. The entry charge was removed and other requirements were relaxed.
The results have been marked. Only three companies became REITs in each of 2009 and 2010, just two companies took the plunge in 2011 and the number of new entrants hit a low of one in 2012. However, 2013, the first year following the introduction of the new rules, saw five new REITs and there were a further six in 2014. There have already been three new REITs in 2015.
Many of the recent spate of entrants to the UK REIT regime are newly established property investment funds. It is highly likely that these funds would have been set up offshore before 2012. There are also a number of companies, including the Standard Life and F&C funds referred to above, that were offshore and have decided to bring their businesses onshore. It is inconceivable that this would have happened before the 2012 REIT rule changes.
There have also been cases of properties held by private investors being repackaged and launched as REITs with a view to widening their ownership over time. In these cases, a stock market listing provides the opportunity for the existing investors to sell their shares in the secondary market and gives the REIT access to an additional source of capital for growth.
Investor demand for REITs is strong. This is clear from the share price performance of many newly launched REITs and is borne out by the experience of fund managers on the fundraising trail. The REIT “brand” appears to resonate with both institutional and retail investors. In addition, the relatively high-yielding nature of many REITs satisfies the continued demand for income-producing assets in the current low interest rate environment. Furthermore, the use of onshore structures seems to be well-attuned to the public attitude towards what are perceived as complex or aggressive tax-planning measures.
Although it is too early to say, it may also be the case that REITs, along with investment trusts and other listed closed-ended investment funds, will be beneficiaries of the pensions reforms announced last year, which will provide greater freedom as to how retirees choose to utilise their pension pots.
There are some downsides to the use of the REIT structure. REITs are not suitable for businesses with a strong focus on development, although some development activity can be accommodated. There are rules on financing costs, which can be an issue for highly geared companies, and some administrative work is required to be REIT-compliant. However, set against these issues are factors such as a potential advantage in corporate M&A due to the REIT’s ability to eliminate latent capital gains. And a REIT, unlike an offshore company, does not require infrastructure in an offshore jurisdiction.
Of course, the UK has a considerable way to catch up with the US, where REITs have been in existence for decades. The US REIT sector is worth well in excess of $800bn (£518bn) at the last count, vastly bigger than the UK’s sector. REITs are also well established in Australia, Canada and in Asia, particularly in Japan and Singapore.
There will be cases where other structures are more appropriate. However, it seems likely that REITs will increasingly become the “new normal” for UK real estate investment.
Richard Werner is a partner at Berwin Leighton Paisner
