insight SERIES Property Week Guide to UK Week Property REITs UKGUIDE TO REITs

In association with: News CONTENTS

5 Welcome

6 What are REITs and why are they important?

Stephen Hester, chief executive of British Land, Residential Professional Analysis explains the significance of REITs

14 What is about to happen in the UK… Will we see more frenzied M&A activity? Plus, a list Regional Regional of companies likely to convert

16 Steps to becoming a UK REIT Joining the REIT regime is straightforward but some of the steps need careful consideration Classified

20 Preaching, from the converted British Land chief executive, Stephen Hester, reveals his vision for the future of REITs

24 REITs and the investment market The impact REITs will have on the investment market

28 REIT FAQs The pros, cons and myths explained

32 Expert forecast Six agents and money-management experts forecast the impact that REITs will have

36 Five years on… The influence of REITs in five year’s time

38 The structure of a UK REIT The precise structure of the UK regime

42 Tax implications How REITs are treated for tax

British Land’s Leadenhall 44 Sponsor profiles Building development, London EC3, will provide Grade A office space. 48 Glossary

News WELCOME

Tel: +44 20 7921 8350 IT IS MY PLEASURE TO INTRODUCE [email protected] this Property Week Guide to UK CMP Information, REITs. From 1 January 2007, Ludgate House, 245 Blackfriars Road, British Land and other major London SE1 9UY property companies expect to Residential Professional Analysis become REITs and so begin a PROPERTY WEEK REIT GUIDE new era for UK property EDITOR Simon Fellows investment. ART DIRECTOR Carla Pryce In narrow terms, REITs are a new tax treatment, ILLUSTRATIONS Matt Pattinson Regional PRODUCTION TEAM providing quoted property companies with tax Laura Hunt, Sarah Jones transparent status, which many less accessible PUBLICATION DIRECTOR Jo Fellows investment vehicles already enjoy. As a result, property strategies are unlikely to change much. But over time, how

PROPERTY WEEK Classified EDITOR Giles Barrie property is held influences the nation’s savings’ choices BUSINESS DEVELOPMENT DIRECTORS and a more efficient property market promotes both UK Emma Smith, Stuart Arnold economic productivity and our physical environment. ADVERTISING PRODUCTION REITs’ accessibility and professional management will Fellows Media Ltd directly support these Government goals. SALES DIRECTOR It’s an important time for UK real estate. Asset values Christopher Kilbee have been favourably repriced versus stocks and bonds. PUBLISHER Sanjeev Khaira This new price basis needs to be consolidated, supported EDITORIAL ENQUIRIES Tel: +44 20 7921 8561 by the REITs format. Providing a modern, appealing built environment for its customers, REITs will showcase, in accessible form, the appeal of long-term, predictable and growing cash flow to investors. fml And in a broader context, UK REITs are welcome. Produced by Fellows Media Ltd Globalisation of capital markets powerfully reduces the (FML), The Gallery, Manor Farm, importance of national borders. But London, as a key Southam, Cheltenham, Gloucestershire GL52 3PB global centre to intermediate and direct these capital Tel: +44 1242 259241 flows, needs to stay at the forefront of investor choice [email protected] and freedom. REITs are another tool so to do. www.fellowsmedia.com We look forward to a flourishing REITs market and I © CMP Information Ltd 2006 commend this guide as an essential primer. The profile pages contain paid-for editorial that allows those named to highlight their projects. The information included in them in no way reflects the views of Property Week, Fellows Media Ltd or the editorial/production team. Every care is taken to avoid mistakes but Stephen Hester neither the publisher nor Fellows Media Ltd can accept liability for inaccurate information published in CHIEF EXECUTIVE OFFICER this UK REIT Guide. THE BRITISH LAND COMPANY PLC 6 What are REITs? www.propertyweek.co.uk

What are REITs and why are they important?

■ The introduction of the Real Estate Investment Trust model is being hailed as the most significant development in the UK property industry for a number of years. It is expected to boost publicly-listed companies as vehicles for investment in real estate, writes Stephen Hester, CEO British Land

UK REAL ESTATE INVESTMENT TRUSTS (REITs) will be the generic name for listed British property companies opting into a new tax regime beginning 1 January 2007. The regime allows companies to be free of income and capital gains tax, in exchange for one-off tax payments. The companies also submit to a light- touch regulatory regime, including requirements to pay higher dividends, and certain restrictions on capital structure and business focus. The model has been in existence in other countries for many years and has flourished in www.propertyweek.co.uk What are REITs? 7 8 What are REITs? www.propertyweek.co.uk

the US, Australia, France, Netherlands, A GREAT OPPORTUNITY THAT WILL NEED Japan and Singapore. INDUSTRY CO-OPERATION TO REALISE… Historically, investment in quoted DAVE BUTLER, PROGRAMME CO-ORDINATOR, REITA property companies has been the domain of institutional, rather than THE POTENTIAL IMPACT OF REITS AS A TRIGGER FOR private investors, whose indirect fund private investors to enter the listed property sector investments have tended to focus on must not be underestimated. Some commentators more tax-efficient property vehicles. have predicted rapid growth from today’s market The new REITs’ regime redresses this value of £40bn to £100bn within a few years, but this balance and should make the quoted growth will not happen unaided, nor will it be property sector more attractive to without risk. investors, both old and new. In the US, more than 30% of investment in the listed property sector comes from private investors, INVESTING IN PROPERTY through direct investment in REITs or collective Property has unique characteristics investment schemes. To grow private investor suitable for savers: participation to anywhere near this level in the UK will ■ It boasts long-term, stable income require a sustained, cross-industry effort to educate from rents. The security provided by investors and their advisers about both opportunities land, bricks and mortar have combined and risks in the sector. Recent research by Reita, the with prospects for capital growth to campaign to increase awareness and understanding of make it the best-performing asset class REITs and quoted property investment, indicates that of recent years: one that also diversifies less than 20% of financial advisers understand REITs, investors’ risks. while nearly 50% see REITs as being part of their ■ Investors have always faced a clients’ investment portfolios next year. The dangers of dilemma over the most appropriate this information gap are significant – advisers do not route to property ownership. The most sell products they do not understand, whilst direct route is simply to buy some misunderstood investment opportunities inevitably buildings. However, property comes in lead to market risk and disillusioned investors. large lot sizes, it has to be managed, it It may seem obvious to those in the industry that is costly and time-consuming to buy commercial property is fundamentally different from and sell: selecting investments is a job residential ‘buy-to-let’. It is, however, by no means best left to the experts. obvious to private investors considering investment in a REIT or a property fund containing REITs. The efforts However, owning property through a of individual property and investment companies must UK company has had the disadvantage be supplemented by non-partisan information that that tax is paid twice on the same both the adviser and investor, whatever the state of income – once when the company is their knowledge, can use to make informed, safe and taxed on its rental income and capital realistic decisions. growth, and again when the revenue is Transparency, continual communication and easy paid out as dividends. Many property access to information in language that the private investors have been able to avoid this investor can understand have been key drivers in the tax burden by investing in property held long-term success of the US and Australian markets: offshore, in highly-leveraged vehicles this lesson must also be learned here. The property or through tax-exempt institutional industry has worked together in an unprecedented funds. As a result, quoted property way to bring REITs into reality. This co-operation must companies have had to operate at a be built upon, if their future success is to be assured. considerable fiscal, and therefore commercial, disadvantage to other property investment vehicles. 16 Steps to becoming a REIT www.propertyweek.co.uk

Steps to becoming a UK REIT

■ Joining the REIT regime is straightforward but some steps will need careful consideration reports Christopher Luck, partner, Nabarro Nathanson

HOW DOES A UK COMPANY on a property rental business implement the decision to join (broadly, a UK business the UK REIT regime on or after exploiting an interest in land) 1 January 2007? and fulfil a number of conditions: STEP 1. SATISFY THE QUALIFYING CONDITIONS A. The six company qualifying The first step to achieving UK conditions REIT status is to make any A UK REIT must: changes necessary to ensure ■ be solely resident in the UK that the conditions of the for tax purposes regime are satisfied. The ■ not be an open-ended potential UK REIT has to carry investment company www.propertyweek.co.uk Steps to becoming a REIT 17

■ have a listing on a recognised stock exchange ■ not be a close company ■ have one class of ordinary share and no other shares except non-participating fixed rate preference shares ■ not have any excluded loans (broadly profit linked, asset linked or non-commercial).

Thus, private companies and companies listed on AIM cannot elect for UK REIT status. Some overseas exchanges, such as the Channel Islands, are ‘recognised’ by HMRC.

B. The four tax exempt business conditions To be a tax exempt property rental business, the property rental business carried on by the UK REIT must: ■ contain at least three single rental properties ■ not contain a property representing more than 40% by value of the rental portfolio ■ not contain any owner- occupied properties ■ distribute at least 90% of its rental profits by way of dividend.

C. The two balance of business conditions As regards the activities the UK REIT is permitted to undertake: ■ at least 75% of the total income profits of the UK REIT must arise from its property rental business; and ■ the value of the company’s assets in the property rental business must be at least 75% of the total value of all its assets. 18 Steps to becoming a REIT www.propertyweek.co.uk

STEP 2. CONSIDER FURTHER CHANGES MAKE ANY CHANGES NECESSARY TO Any potential UK REIT will need “ENSURE THE CONDITIONS OF THE to consider what legal and structural changes it should REGIME ARE SATISFIED make for greater tax efficiency before joining the regime. In order to avoid a possible corporation tax charge in the event that a corporate shareholder breaches the 10% shareholder limit, a potential UK a UK REIT is required to provide are reasonably” expected to be REIT should examine its HMRC with written notice of satisfied throughout the Memorandum and Articles of that election before the accounting period specified in Association. It should then make beginning of the first the notice. any changes necessary to allow accounting period during HMRC has reserved the right it to establish that it has taken which it wishes to be a UK to require that further ‘reasonable steps’ to avoid the REIT. For a Group UK REIT, the information is provided in the payment of a distribution to principal company (the notice. No prescribed format of such a shareholder. company at the top of the the notice has been issued. A potential Group UK REIT group) must make the election. should also look at the There is no minimum time STEP 4. PAY THE ENTRY structure of any borrowings limit for giving notice. CHARGE within the group and ensure The company must satisfy, at The entry charge is equal to that the effect of such the time it gives notice, the 2% of the gross market value borrowings on the 90% first three company qualifying of the properties used within distribution requirement, the conditions: it must be UK the property rental business. 75/25 income test and the resident for tax purposes, listed The market value is calculated reduction of tax on the residual on a recognised stock exchange at the date on which the business are understood and and it cannot be open-ended. company becomes a UK REIT. are appropriate. When submitting the notice, The entry charge will be the electing company should collected in four quarterly STEP 3. NOTIFY HM REVENUE also present a statement instalments at the same time & CUSTOMS declaring that all six of the as corporation tax is payable, A company electing to become company qualifying conditions generally commencing six months after the beginning of At least 75% of the total the first accounting period. income profits of the UK REIT must arise from its Alternatively, companies can property rental business. elect to spread the entry charge over four years, in instalments of 0.5%, 0.53%, 0.56% and 0.6% (2.19% in aggregate, an effective rate of interest of about 6%). If the UK REIT leaves the regime within three years, any remaining instalments are brought into charge immediately. A company wishing to spread www.propertyweek.co.uk Steps to becoming a REIT 19

On entering the regime, the company will be deemed to dispose of and reacquire at market value the properties to be used in the tax exempt property rental business.

the entry charge over four STEP 5. STAY WITHIN THE from the regime (either on years must notify HMRC of this REGIME notice or through automatic decision at the same time as On entering the regime, the termination on certain electing to join the REIT company will be deemed to breaches by the company of a regime. Choosing to spread the dispose of and reacquire at qualifying condition). cost of the entry charge is market value the properties to Where companies elect to generally irrevocable, although be used in the tax exempt leave the REIT regime within the charge is refundable in property rental business. Any ten years of joining, and certain very limited chargeable gain or loss arising dispose of any property that circumstances. For example, on the deemed disposal will was involved in the tax exempt where a property previously not be brought into account for property rental business within used in the tax exempt tax purposes. two years of so leaving, any property rental business is sold Once within the UK REIT uplift in the base cost of the in the course of the UK REIT’s regime, the company will property that occurred under residual business, that property generally retain its status until the regime will be disregarded. may be treated as if it were it issues a valid notice on HMRC This will, potentially, result in a never within the tax exempt to leave the regime (specifying higher capital gain or lower property rental business and a date of cessation after the allowable loss than would the entry charge paid in date on which the notice is otherwise be the case. There respect of that property could received by HMRC) or until will be no rebate of the entry be refunded. HMRC withdraws the company charge in such cases. 20 Interview www.propertyweek.co.uk www.propertyweek.co.uk Interview 21

Stephen Hester plans to convert British Land into a REIT in January 2007.

Preaching, from the converted

■ Property Week editor Giles Barrie talks to British Land chief executive Stephen Hester about conversion, the consequences and the competition

TRIGGER FOR AN OVERNIGHT REVOLUTION? NO. A spark for a fundamental shift in the status of the property sector as an asset class over three to five years? Absolutely. This is a summary of British Land chief executive Stephen Hester’s view on the arrival of UK REITs. And if anyone is qualified to say, it is him, with nearly 25 years at Credit Suisse First Boston, as chief operating officer at Abbey and at British Land since 2004 under his belt by the age of 46. Unlike many property men who grew up buying, selling and leasing property, Hester has a broader financial perspective. This is also an ideal qualification for his role as Sir John Ritblat’s successor at British Land, given Britain’s second biggest property company’s traditional strength in the financing element of real estate. In his first two years he has spent more than £800m buying Pillar, ramped up its London development programme and moved to quarterly reporting. He also played a major role in persuading the Government of the merits of 22 Interview www.propertyweek.co.uk

REITs, and plans to convert British Land into GETTING THE PROPERTY a REIT in January. `Apart from our conversion charge, the cost “MARKET RIGHT IS MORE of becoming a REIT is one fax to the Inland Revenue: 2p for the paper and 10p to send the IMPORTANT THAN GETTING fax: that’s how simple it is,’ Hester says.

DIVIDEND POLICY YOUR TAXES RIGHT. British Land is the first company to declare its dividend policy under the REIT regime. It will move to quarterly payments and the first full year REIT dividends will be at least 94% higher than 2005/2006. Dividend policy is a key aspect of REITs as, in ” addition to being measured according to Net Asset Value, there will be increased scrutiny of dividends. This is because a key attraction of REITs will be their enhanced payouts on the back of becoming exempt from corporation and capital gains tax. Dividends and their growth will certainly be a more important component of return than before, but still only an element alongside capital appreciation. Overseas REITs, after all, do pay out more than UK investors are used to. Hester says: `Everyone points to Australia and says UK REITs are bound to yield six per cent. That simply isn’t true. The average UK REIT will

yield less than three per cent, for the simple The industry must not make promises reason that property yields in Britain are lower to the public it cannot keep says Hester. than in other countries. `There are two very good reasons for that: first, we are a densely populated island, and land is at the merits of two other big REIT talking points: a a greater premium than everywhere else. perceived need for scale and sector-specialisation. `Second, the legal structure surrounding our While analysts point to the US to show that all leases is more favourable than in other countries. but one of the top 10 REITs are monoliths Hester points out that in Australia not only are specialising in one type of real estate, Hester higher interest rates the norm, which tends to argues that Britain is altogether different. also mean yields are higher, but with land `Changing a tax rate doesn’t change any of the supply so much less constrained there is also arguments about scale or diversification that less prospect of capital growth. apply ahead of REITs. The result? More of an emphasis on distributing `I sometimes smile when I hear these debates income than increasing asset values, which for the in property as if they are something new. In every last three years at least has been the compelling industry across the world there are ebbs and argument behind soar-away property shares. flows of fashion over diversification and scale. `Hanson was unbelievably successful as a SIZE AND SPECIALISATION conglomerate for a long time, then became Being investment banker turned FTSE-100 chief unsuccessful, broke itself up and the pieces have exec has its advantages for Hester when debating done very well. GE was very successful as a www.propertyweek.co.uk Interview 23

conglomerate, decided to specialise as Marconi impact on the direct property market. Opinions and went spectacularly bust. have ranged from forecasters at DTZ saying they `Brixton is focused on industrial property, but will increase activity by 40% in the medium term is diversified between the Heathrow and Park to others who say they will slow things down. Royal markets. One person’s specialisation is The latter theory is based on the fact that another’s diversification. even if their dividend payouts are lower than `The fact is that a company’s job is to make REITs abroad, UK REITs will still be distributing money for its shareholders, and to do that you’d more earnings than now, perhaps limiting the better be good at what you do but there is no amount they develop. evidence that corporate advantage is restricted This has even led experts at smaller to a particular range of activity, number of developers unlikely to convert into REITs units, or territorial limit.’ privately predicting a `brain drain’ from the big Hester explains that to compare British guns to smaller, livelier outfits. companies with giant US REIT Equity Office, now That’s what they are predicting, anyway. being taken over, and which is often held as the Hester sees things differently. model for sector specialisation is wrong because `Today we are buying, developing and selling its activities are actually very widespread. a lot and we will do tomorrow. There may be `I can tell you that managing offices in some things bought and sold that otherwise Seattle, Chicago, Florida and New York is might not have been. infinitely more diverse, difficult and challenging `It’s quite possible we will actually see some than managing in every property sector in one increase in velocity or recycling.’ This appears small country like the UK,’ he says. perfectly logical, given that companies like Land Take it as read, then, that British Land is likely Securities or British Land will from January all to remain focussed for some years yet on central suddenly be able to sell properties they have held London offices and retail. It is also investing for years without incurring vast capital gains. opportunistically in properties with index-linked So, changes to the scale and breadth of the leases to hedge it ahead of the days when yields quoted sector, and a possible upsurge in activity no longer fall. among quoted companies. So according to Hester REITs will not mean sky-high dividends, bigger property companies FUNDAMENTALS or greater specialisation. But the biggest message of all from Hester is that This is not to say, though, that he does not REITs will still fundamentally rely on a healthy think they will create great change. property market and sensible property thinking. With REITs starting to share the tax advantages A tax wrapper that makes them a more enjoyed by the hordes of offshore trusts created appetising prospect than property companies in recent years, and private companies now with now should not compromise their thinking, is a disadvantage, he expects an expansion in the his fundamental point. `Getting the property size of the quoted sector. market right is more important than getting `I think there will be more flotations of UK your taxes right,’ he says. property companies than there have been. That Big changes are ahead, and with the will increase investor choice, be good for investment boom continuing the property liquidity and therefore the economic efficiency industry must be careful not to sucker an eager of the property market. public into new vehicles that make promises `But it would be a pretty good bet that Land they cannot keep. Securities and ourselves will still be the number But if REITs are marketed professionally and one and two, with the Hammersons, the Sloughs run well even Stephen Hester, who has seen and Brixtons tucked in behind.’ more than most in financial markets, will not The biggest question about REITs for the be surprised if they become one of the British majority of Property Week readers are their likely punter’s investments of choice. 24 Investment market www.propertyweek.co.uk

■ Mathew Crowther, assistant director, Rothschild, and Simon Fellows explore the impact REITs will have on the investment market REITs and the investment market

REITS WILL INTRODUCE TWO KEY BENEFITS – tax efficiency and liquidity. These will transform the UK property market, but will they send ripples or waves sweeping through the investment market?

REIT WINNERS The clear winners of the new tax- efficient structure that REIT legislation brings will be pension funds and tax sheltered personal finance wrappers like ISAs and SIPPs. Any income profit and capital gains from a REIT’s qualifying property rental business will be exempt from tax and the REIT will be able to distribute 100% of this tax- exempt income to pension funds, ISAs and SIPPs, which, because of their exceptional status, will not be subject to taxation. Non-REITs have to pay corporate tax of 30% on income profits www.propertyweek.co.uk Investment market 25

and capital gains, effectively limiting such a distribution to just 70%. This, of course, has a positive knock-on effect for independent financial advisers (IFAs) who will have a key role in educating and offering these investments to smaller private investors. Private and institutional investors alike will also benefit from the increased liquidity REITs bring the market because, for the first time, it will be easy for all classes of investor to invest in the commercial property market.

MARKET ACTIVITY The real success of REITs will depend upon increasing public awareness of these new vehicles. Interest from institutional investors is expected to be strong, but IFAs will be a vital link to arousing the interest of smaller private investors. So far, the signs are positive – the excellent Reita campaign has made the IFA industry very REIT aware, which in turn is now priming clients for the New Year launch. According to The Times (20 November), 44% of IFAs will recommend REITs to their investors, most probably through ISAs and SIPPs. One of the drawbacks of direct property investment is that it lacks liquidity, but UK REITs will get around this by enabling investors to buy and sell easily traded units. Therefore, the introduction of REITs opens up exciting new opportunities for small investors in the UK, where access to quality commercial property investment has traditionally been limited to bigger institutional investors. Most significantly it will allow individual investors to invest indirectly in a diversified property portfolio, buying low cost and easily tradable units instead of having to finance the purchase of whole properties. This liquidity gives REITs a huge advantage over unit trusts and open- ended investment companies (OEICs), because the latter have to keep a 26 Investment market www.propertyweek.co.uk

Gareth Lewis, Director of Finance and Investment at the British Property Federation, believes that the success of REITs will partly be judged by the amount of new investment they bring to the market. ‘One point of view could be that a successful UK REIT market would be a market that reaches the current market capitalisation of the existing UK quoted THE INTRODUCTION OF REITS property sector (approx £40bn) in a relatively short period of time,’ he says. OPENS UP EXCITING NEW ‘However, this reshuffling of the “ existing investment market should not OPPORTUNITIES FOR SMALL be considered a sufficient criterion to qualify the REIT regime as a success, INVESTORS IN THE UK given that the bulk of the assets finding their way into the regime in this scenario would come from existing property plcs (and their shareholders) becoming bigger rather than from new money finding its way into UK property. The measurement of success of the UK ” REIT market should be judged on the significant proportion of their funds amount of new capital attracted to the outside direct property investment, in market from new sources.’ case investors want to sell. The ease Lewis believes that, despite there with which investors can buy or sell being an abundance of net capital units in REITs makes them an attractive inflows into the commercial property flexible proposition for property market (£69.5bn in 2005 from £22bn companies and investors alike. in 2004, Money into Property - DTZ Research, Summer 2006), new NEW MONEY investment from private retail investors It’s anticipated that these advantages, is vital. ‘In my view, a truly successful together with the increasing public REIT market, both from the awareness of REITs and, hopefully, its Government’s and property industry’s eagerness to invest in them, will perspective, needs ‘buy-in’ from the prompt investment banking groups and private retail investors more than they financial services companies to become need it.’ he says. REIT managers, building new property So, is the REIT package sufficient to portfolios funded by retail investors capture the public’s imagination? through the IFA network. Close Brothers Property investment is so deeply Investments, Rock Capital Group and embedded in the nation’s psyche that the Matrix Group, to name a few, all the residential and buy-to-let property seem likely candidates for this, but it booms we have seen in recent years will be interesting to see whether they have clearly been influenced by the attract new investors to the property increased status these investments market or whether existing investments bestow upon the investor and the will simply be redeployed. opportunity to make a ‘quick buck’. www.propertyweek.co.uk Investment market 27

Put simply, they’re sexy staples of ‘When one looks at the quality of middle-class dinner-party chit-chat. If historic property returns, and the on- REITs can grab onto the tailcoats of this going growth potential, there are current boom, and benefit from the arguments that property is currently slipstream of excitement, the ride will fairly valued. However, the generation be a lot smoother. of sustainable growth from property For the ‘man on the street’ – the will require appropriate asset Government’s main concern – REITs management, as investors cannot rely stack up well when compared to buy- on continuing yield compression to fuel to-let. They are well-regulated, liquid returns. investment vehicles that are expertly ‘Notwithstanding this, the risk of managed and allow private investors market volatility cannot be discounted. unprecedented access to the commercial However, assuming that REITs result in a property market with just a small level net increase of investment into of investment. Buy-to-let ticks none of property, then this is likely to have a these boxes and so, for the stabilising effect on the market, and inexperienced, can be a much riskier potentially mitigate or at least delay proposition. any downward shift.’ What about the cynics that claim that commercial property is already over valued and the last thing the industry needs is a new class of investor FINANCING REITS pumping more money in? Andrew Radkiewicz, managing director, Andrew Radkiewicz, managing Rothschild is convinced that in the process director, Rothschild, believes that this of structuring of a REIT, the debt element view is an over simplification. ‘I think needs to be carefully considered. ‘Managers that if one looks at the market now it’s should give serious consideration to looking unfair to say that commercial property beyond traditional bank finance for their is generally over valued,’ he says. funding,’ he says. ‘Bespoke capital markets ‘It is clear that property yields have, structures through stand alone branded for a while, been correlated with CMBS, present an excellent option, given medium term interest rates, due to the that REITs are likely to be large in size; proportion of highly geared private benefit from asset diversity; and have property company investment. However, investment grade level gearing.’ the yield gap has closed considerably, The advantages are numerous suggests which implies that although interest Radkiewicz. In addition to substantially rates are still an important factor, other lower funding costs, structures can be market forces need to be examined. tailored to meet individual business plans. ‘Why has the yield gap closed? They can include substitution flexibility; Although interest rates have increased, allow for asset management; cater for capex there is still liquidity coming in from requirements; as well as future growth, lower- or un-geared structures, with the ability to access significant particularly foreign money and additional funding. He adds: ‘The key, institutional fund redeployment. however, is to obtain experienced external Investors then have to look at how advice, to ensure that the structures work property returns rank against other and are executed efficiently with rigorous investment classes – equities, bonds real and opportunity cost control.’ and particularly longer term gilts as benchmarks. 28 REIT FAQs www.propertyweek.co.uk

■ Experts from Nabarro Nathanson, Reita and Rothschild answer some fundamental questions about REITs REIT FAQs

CAN RETAILERS AND WILL SHARE PRICES OTHER COMPANIES WITH ESCALATE AS A RESULT QLARGE PROPERTY QOF REITS? HOLDINGS BECOME REITS? ROTHSCHILD Listed property NABARRO The difficulty with companies have seen a this statement for retailers significant increase in the is that the REIT will have to share price in anticipation become an independent of REITS, however the tight company of the retailer UK yield gap and those because properties REITS with sole exposure occupied by the REIT or to the UK market may put occupied by any other pressure on share prices. group REIT company are excluded from the regime. www.propertyweek.co.uk REIT FAQs 29

WILL REITS FORCE WILL SECTOR-SPECIFIC ARE REITS A NEW PROPERTY COMPANIES REITS DELIVER BETTER ASSET CLASS? QQTO CHANGE STRATEGY? QRETURNS AND BIGGER DIVIDENDS? NABARRO In the US market REITA The introduction of they have tended to act in UK REITs will bring NABARRO The UK REIT a similar way as an additional external market may follow the US investment into a utility pressure on property market into sector share with regular growing companies to refine, focus specialist REITs, allowing dividend income, rather and communicate their investors to direct their than as either direct real strategies to compete for money towards their estate investment or a and retain investors and chosen sector. Not shareholding in an to deal with the threats everyone sees this as a ordinary corporation. and opportunities of route to better returns and consolidation. Additionally bigger dividends, not least ROTHSCHILD As the sector REITs will bring real those property companies grows it will open up advantages to attaining that currently have a wider investment options scale and this is likely to diverse portfolio and have in the property sector. become a factor in given no indication that successful strategies. they will become sector specialists in the run up to ROTHSCHILD Property REIT conversion. companies have existed in the UK for years, but have ROTHSCHILD REITs share generally traded at prices will also be affected discounts to the net asset by general performance of value of their underlying the equity market, property holdings due to however the tax the inefficient corporate advantages will enable structures of the them to go for scale and companies themselves. The sector specialisation more efficient tax should enable them to structure of REITs should drive down cost ratios. close this gap, providing property companies with a serious alternative to offshore unit trust and OEIC structures and which on balance should make the listed REIT route a popular option for a wider range of property companies and funds looking to raise capital in the UK. 30 REIT FAQs www.propertyweek.co.uk

WILL THERE BE A SURGE WILL ALL OFFSHORE WILL COMPANIES IN SHARE TRADING FROM INVESTMENTS MOVE CONVERTING TO REITS QQPRIVATE INVESTORS WHEN QONSHORE? BE MORE EFFICIENT AND REITS LAUNCH IN THE UK? COST EFFECTIVE THAN NABARRO Investors will be THOSE THAT DON’T? REITA There may be an encouraged to consider UK additional initial surge in REITs as serious REITA There is no intrinsic share trading from private alternatives to offshore reason why a REIT should be investors following publicity vehicles, such as offshore more efficient than a around the January launch. unit trusts. However, quoted property company of However, full participation investors who cannot or the same size; however, will require increased choose not to meet certain experience around the awareness and UK REIT requirements (the world has shown that scale understanding of the sector listing, the 10% is a key factor for successful by private investors and shareholder rule) will REITs and scale delivers the their advisers and this will continue to turn to the opportunity to reduce unit take time to develop. well-known and familiar costs through economies of Further in the short term at offshore vehicles. The ability scale and the ability to least, most private investors to deal in the units free of spread fixed costs across a are likely to participate in UK stamp will continue to larger number of assets. the sector through collective attract many investors to investment vehicles. offshore unit trusts. ROTHSCHILD The REITs’ legislation eliminates many ROTHSCHILD For the first REITA Currently, there are costs and embedded tax time, a product that no obvious reasons for liabilities of existing property equates quite closely to a offshore investment trusts companies by taking away direct stake in property will to come onshore. These the ‘double taxation’ be offered to the investing trusts are effectively tax (corporation tax plus the tax public. It will, therefore, be transparent and liquid on dividends) of ordinary subject to many of the and the 2% conversion property funds. Also by same influences that apply charge is a significant requiring REITs to distribute to shares. barrier to change. a high percentage of income to shareholders, REITs should more closely replicate the investment characteristics of direct property ownership. For property companies that do convert to REITs, the more efficient tax structure should close the gap THE REITS LEGISLATION ELIMINATES between share prices and MANY COSTS AND EMBEDDED TAX net asset values making “ REITs more competitive with LIABILITIES other direct property ” investment vehicles. www.propertyweek.co.uk REIT FAQs 31

IS NOW NOT THE TIME TO WILL REITS BE THE HAVE SMALL PRIVATE INVEST IN A REIT - IS CATALYST FOR A WAVE OF SHAREHOLDERS BEEN QQTHE PROPERTY MARKET QCONSOLIDATION/M&A UNABLE TO INVEST IN REACHING THE TOP OF A ACTIVITY IN THE PROPERTY COMPANIES CYCLE? PROPERTY SECTOR? UNTIL NOW?

REITA The performance of REITA We are already seeing NABARRO One of the the property market and the start of this activity and driving forces behind the of property funds and it is likely to continue, both UK REIT regime is to shares in recent years has as UK companies seek to attract those investors that been exceptional and is achieve scale, REITs and previously have only unlikely to be matched other investors seek to invested directly in going forward, not least acquire non-REIT assets and property. The ability to because returns have been additional fund inflows spread their risk in a in part driven by one-off facilitate transactions. In relatively safe and factors such as repricing in doing so, the UK will follow protected vehicle should anticipation of REITs. well-established patterns encourage small investors. However underlying from REITs’ markets around drivers such as tenant the globe. REITA Whilst it has always demand remain strong been possible for small and this is reflected in the ROTHSCHILD The REIT private investors to forecasts of significant legislation will create a tier purchase shares, it has dividend increases by of entities with a predatory been relatively tax- many of the companies advantage - those inefficient and unattractive converting to REIT status. companies that expect to compared to the rewards ROTHSCHILD A sharp be in the REIT environment on offer through either setback in commercial real can search through those collective investments or estate values would not be outside it and use the tax residential ‘buy-to-let’. The good news for emergent arbitrage between the two removal of double REITs. However, the weight environments to bulk up a taxation, the focus that of money expected to be takeover offer. (i.e. of two REITs will bring, a growth redirected through REITs companies looking to take in knowledge over the long and new monies coming over a target company, the term and the development in will probably prolong one within the REIT of retail investor focussed the bull market and put environment can afford to propositions will provide more pressure on yields in pay more than a company real encouragement for the short term. outside the REIT tax shelter). retail investors, small and large, to take full advantage of the quoted property market, both in REITs and property companies. 32 Expert forecast www.propertyweek.co.uk

Expert forecast

■ Six leading agents and money management experts forecast the immediate effect the REIT regime will have www.propertyweek.co.uk Expert forecast 33

CB RICHARD ELLIS CUSHMAN & WAKEFIELD

PETER DAMESICK, HEAD OF UK RESEARCH, BRYAN LAXTON, CEO CAPITAL MARKETS GROUP, CB RICHARD ELLIS CUSHMAN & WAKEFIELD

‘BUSINESS AS USUAL WITHIN A DIFFERENT TAX REITS SHOULD BE A MAJOR FORCE SHAPING THE UK wrapper’ seems to be the prevailing view of life property market but their impact will be gradual as a REIT among the major property companies rather than dramatic. who are prime candidates for conversion in 2007. The government has produced a more flexible At face value, this suggests REITs will not structure than many expected, but restrictions substantially alter the character or dynamics of the remain, not least the stipulation that REITs must UK investment market and the REIT investor base first be listed on a major exchange. will be little changed from that of the existing Investor interest in REITs looks likely to be quoted sector. good meanwhile, even though some will hold In the short term, however, the new tax back until underlying performance becomes wrapper will have some impact. Freedom from tax clearer. Moreover, competition for investors’ on income and capital gains will influence REIT money will remain high, particularly if the investment behaviour. Income becomes more listing authorities allow JPUTS and Limited attractive and there is already evidence of REIT Partnerships to be listed, which we understand candidates looking to acquire ‘drier’ income- is under consideration. producing assets which would previously have Property demand from the REITs may be been of less interest. restricted by the current market cycle, but the Corporate acquisitions by REITs of entities removal of the barrier of tax considerations holding assets with CGT liabilities will clearly be should lead to further activity and the fact that attractive, in view of the ability to transfer such many will be sector focussed should also assets into REITs with only a 2% tax charge. encourage trading. Moreover, demand for REITs Likewise, certain REITs will take the opportunity to should encourage capital raising and, hence, make tactical or strategic asset disposals that more direct investment. would otherwise have triggered CGT liabilities. Market consolidation has been a key trend in Whether REITs bring more fundamental market other markets after REITs have been introduced change, with the UK sector becoming more like and we expect the current M&A trend to that in the US for example, will depend ultimately accelerate as smaller companies are taken over on whether investors prove to want something or bulk up to enter the REIT market. Indeed, different from REITs than from existing listed ‘big’ may be seen as ‘beautiful’, if the new REITs property companies – higher dividends, less are to maintain their independence and not fall development, more specialisation by sector. prey to international entities. 34 Expert forecast www.propertyweek.co.uk

DTZ JONES LANG LASALLE

ROBERT PETO, CHAIRMAN OF DTZ DEBENHAM CHRIS JOLLY, MANAGING DIRECTOR, JONES TIE LEUNG LANG LASALLE CORPORATE FINANCE

REITS OFFER EXCITING OPPORTUNITIES, THOUGH SOME THE ADVENT OF REITS WILL PRODUCE A CLASS OF are likely to view them as additional, not property owners which will be able to exploit its replacement products. Initially, I would advantageous tax status to outbid tax paying anticipate plenty of activity, while REITs position competitors. This will encourage vendors and, themselves in the market and then go for scale therefore, should increase market volumes in to drive down administration cost ratios. After the short term. It is less clear whether REITs will initial conversions, I think we’ll start to see continue to churn their portfolios actively, once specialist sector REITs emerging such as they have reached their target size. Evidence, residential, hospitality and medical offices. from Australia, would suggest that they will be The lead is likely to come from the quoted less active buyers and sellers than traditional real estate sector, with others following. We property companies. expect growth to come from non-real estate The volume of assets held by the likely companies or property-rich ones. We are converters is only a fraction of the investment forecasting that the UK REIT sector will have an property market in the UK. Therefore, we need aggregate market capitalisation of approximately to look to IPOs of unlisted companies or funds to £12 billion by end of 2007. increase the volume of assets managed by I also think that market capitalisation of UK quoted REITs. Alternatively, the government REIT structures will exceed traditional real estate needs to amend the legislation to permit companies by the end of 2009, and by 2010, it unlisted REITs, thereby replicating the US will be in the region of £44 billion, which is situation – an approach which has helped the consistent with the experience of other significant expansion of the REIT sector there. international markets. Lobbying will be needed to encourage this There are two short term caveats. The first is relaxation as soon as possible. the market cycle, which may slow progress, and the second is the possibility that share investors will place greater emphasis on dividend yield than NAV. The confluence of both these events could put pressure on share prices for those REITs with sole exposure to the UK Market. www.propertyweek.co.uk Expert forecast 35

KNIGHT FRANK SAVILLS

JOHN STYLES, PARTNER, KNIGHT FRANK ANDREW CAUSER, DIRECTOR OF CORPORATE INVESTMENT MANAGEMENT FINANCE, SAVILLS

IT IS CERTAIN THAT IN FUTURE A SIGNIFICANT THE EQUITY MARKET HAS ALREADY FACTORED IN REITS proportion of UK investment property will be held and continuing strong capital growth over the in REITs. The implications will reach into the next 6-12 months. Most leading shares currently capital markets, the commercial property market, trade on dividend yields of 2.5%-3.0% and and the fund management industry. 10%-15% discount to end of 2007 estimates. There is likely to be rationalisation of property These valuations are not obviously cheap and portfolios by those converting to REIT status. We more brokers are starting to recommend lowering expect to see some of the REIT-aspirant property weightings in the sector. For the main REITs companies selling non-core assets into what candidates to issue equity to grow ratings will remains a hot investment market over the next have to be higher still, and this may not happen. 12 months. More stock could come on the If share ratings drifted off in the face of lower investment market next year as those companies total returns (and stock markets always over- that have converted sell assets which have react), cash bids from cash rich and UK under- increased substantially in value. weight opportunity funds will occur. We do expect further injections of cash into the More money will be raised by the market from private investors via IFAs. Jersey/Guernsey fund management groups, who Will the management of REIT interests sit with can jack up dividend yields by over-distributing, equity fund managers or property fund managers? and this sector will continue to grow. The fund The property industry will clearly hope for the management industry will be a large issuer of latter, which could see increased demand for new funds and this may be the best vehicle for property expertise in the management of REIT investors to make money. share portfolios, which investors will ‘inherit’ as REITs are just another source of equity vying to listed companies convert. compete against cash rich opportunity funds, Experience, in the US and Australian markets, pension funds and Limited Partnerships. Will suggests that REIT shares will be more sensitive to they have the currency to expand? I’m not sure. the volatility of the equity markets than direct property and may become an asset class of their own in performance terms. This, in itself, may well attract more capital into the property sector as investors seek diversification from their traditional equity, bond and property holdings. 36 Five years on… www.propertyweek.co.uk

Five years on…

■ Where will REITs take the property and investment markets in five year’s time?

JULIAN STOCKS, HEAD OF ENGLISH PETER DAMESICK, HEAD OF UK RESEARCH, CAPITAL MARKETS, JONES LANG LASALLE CB RICHARD ELLIS

‘We do not see a significant change in the ‘Over the next five years, without the boost marketplace short-term but moving forward from yield compression, REITs, like all there could be changes in trading activity property investors, will find it tougher to and how portfolios are controlled and drive performance. The REITs sector will owned. In 2007/8 we predict a spike in expand and evolve with some investment trading activity as ex-growth consolidation, greater foreign involvement, stock is sold by the new REITs and they start new entrants and more specialists, bulking up by buying assets and companies. including some in sectors presently outside In 2009 we may begin to see a slow down the mainstream.’ in trading activity as seen in Australia where REITs begin to hold rather than trade stock. By 2010 it could be that the total return model may be out of favour and the sector ELLIOT CALDWELL, SENIOR DIRECTOR AND specialists start to dominate.’ HEAD OF RETAIL INVESTOR PRODUCTS, ING REAL ESTATE INVESTMENT MANAGEMENT

‘Over the next five years REITs will have a BRYAN LAXTON, CEO CAPITAL MARKETS significant impact on improving the GROUP, CUSHMAN & WAKEFIELD awareness and benefit of property as part of a balanced portfolio and will overcome ‘Over time, I expect legislation to be relaxed the concerns of the liquidity of holding to allow private REITs, to encourage property as an asset class.’ international investment and to support owner occupiers switching assets into a REIT. I also see focussed rather than general REITs being dominant. SIMON HOPE, EXECUTIVE DIRECTOR The market will then grow significantly, AND HEAD OF INVESTMENT MARKET encouraging wider investment, greater IN FIVE YEARS transparency and more sophistication.’ ‘REITs will undoubtedly be a major force in the market but they face competition from other forms of capital like LP's, core funds and opportunity funds.’ www.propertyweek.co.uk Five years on… 37

JOHN RICHARDS, CHIEF EXECUTIVE, MATTHEW RYALL, MANAGER OF THE HAMMERSON BLACKROCK MERRILL LYNCH EUROPEAN PROPERTY FUND OF FUNDS ‘The growth in the share prices of the UK listed property companies over the past 12 ‘In recent years we have seen UK institutions months demonstrates that investors already become more at ease at investing in have confidence in the REIT regime devised diversified real estate funds, instead of just by the Treasury. REITs will provide investing in directly held buildings. We companies such as Hammerson with greater believe that over the next five years we will flexibility to make investment and disposal see a major transformation in the way UK decisions as well as opportunities to institutions invest in real estate. As a result broaden the shareholder base.’ REITs will be viewed as part of their property portfolios, in the same way as they are by institutions in the US, Australia and Netherlands. We would therefore expect that IAN HALLY, INVESTMENT DIRECTOR, REAL within five years most UK institutions will ESTATE SECURITIES AT SCOTTISH WIDOWS have at least ten percent of their real estate INVESTMENT PARTNERSHIP (SWIP) exposure invested in REITS’.

‘The introduction of UK REITs won't result in an overnight revolution in the property investment market but, in the next few CRAIG HUGHES, AUDIT PARTNER, years, we expect REITs to transform the way ERNST & YOUNG in which investors access the property market and we are likely to see strong 'In five years time REITs will have become a investor demand for this vehicle. We expect familiar investment vehicle to all investors investors to be drawn to the benefits of a due to education and guidance. Investors will relatively high dividend yield, steady capital have embraced REITs and will now have value growth prospects, professional formed a fundamental part of portfolios. management, better liquidity and good They've branched out from the roots of the diversification characteristics.’ traditional listed property sector, fertilised by a developing regime, new listings and M&A activity, into a range of sectors such as industrial, retail, office, residential, hotels, PETER HICKS, HEAD OF IFA CHANNEL AT pubs, leisure and infrastructure! It will be an FIDELITY INTERNATIONAL exciting journey with the split of investor sentiment between sector specification and ‘The introduction of REITs to the UK is a diversification driving acquisitions, demergers significant development in the global REIT and new entrants. Further, they will have market, and will help to meet increasing created a level playing field from a tax investor appetite for income generation and perspective that the listed sector wanted. portfolio diversification. We believe the REITs of REITs will appear over the horizon introduction of REITs in the UK from January following funds of funds philosophies and 2007 should help propel the overall market models providing the momentum to keep for global REITs towards the $1 trillion mark.’ REITs at the front of investors thoughts.' 38 The structure of a UK REIT www.propertyweek.co.uk

The structure of a UK REIT

■ Christopher Luck, partner, Nabarro Nathanson, looks at the structure of UK REITs

THE HISTORY fenced from any non-exempt activities UK REITS WERE ACKNOWLEDGED IN THE of the UK REIT. pre-budget report of 2003, became the The tax burden in respect of the tax subject of draft legislation in December exempt property rental business shifts 2005 and are now reality for any from the UK REIT to its investors. Hence suitable companies wishing to convert the requirement that a UK REIT on or after 1 January 2007. distribute 90% of the rental profits (in The UK REIT regime aims to provide a the form of a property income dividend) liquid and publicly available vehicle: from its tax exempt property rental opening the property market to a wide business. These distributions are taxed range of investors, including individuals for corporation tax and income tax historically discouraged from indirect purposes as UK property income in the property investment. hands of the investors. The aim is to ensure that the tax treatment for the THE TAX SHIFT investors mirrors, as far as possible, the A UK REIT is exempt from paying tax treatment of those directly investing corporation tax on the profits and gains in property. from its tax exempt property rental Any distributions to the investors of business. This tax exempt portion of a chargeable gains made within the tax UK REIT’s business is effectively ring- exempt property rental business cannot www.propertyweek.co.uk The structure of a UK REIT 39

Likely REIT British Land owns an interest in Ropemaker Place, London EC2. If it converts it will have to adhere to a strict structure.

count towards the 90% distribution requirement, but are also treated as UK property income in the hands of the investors. All property distributions (income and capital) from the tax exempt property rental business will suffer a withholding of basic rate income tax at 22% with a withholding tax exemption for certain entities, including UK resident companies and UK tax exempt bodies (pension funds and charities). For non-UK shareholders any distribution (income and capital) will be treated as a dividend in the hands of the shareholder. Subject to the 10% issue (see over page), relief under the appropriate double tax treaty may act to reduce the withholding. If the UK REIT distributes profits from a part of the business outside the tax exempt property rental business, the distribution will be taxed as a normal dividend in the hands of the investors.

THE CONDITIONS A UK REIT is required to satisfy certain conditions both to join and stay in the UK REIT regime. These are explained in ‘Steps to becoming a UK REIT’ (page 16).

OTHER ACTIVITIES Provided they do not exceed 25% of the company’s activities, a UK REIT can undertake activities other than running a property rental business. These could be ancillary services associated with the property rental business or development undertaken with the purpose of generating a trading profit. Certain classes of income and profits are expressly excluded from being within the tax exempt property rental business. These include certain income currently not treated as property income, such as receipts from transactions falling within the rent factoring tax provisions and dividends from other UK REITs. 40 The structure of a UK REIT www.propertyweek.co.uk

THE GROUP UK REIT THE 10% SHAREHOLDER Groups can achieve Group UK REIT status. A Group UK REIT will comprise a principal Alert to the possibility of a non-UK company and all of its direct and shareholder (resident in a country with a indirect 75% subsidiaries (other than double taxation agreement with the UK) insurance companies and open-ended receiving a substantial dividend from a investment companies) that are also UK REIT without any tax being withheld, the effective 51% subsidiaries of the government introduced the 10% principal company. shareholder rule into the UK REIT regime. Broadly, the conditions of the regime Following consultation and lobbying, this apply either to the principal company rule now only applies to corporate (the six company qualifying conditions), shareholders. or are applied to the entire group (the The rule levies a tax charge on a UK REIT tax exempt business conditions, the that makes a distribution to a corporate balance of business conditions and the shareholder who holds or is beneficially interest cover ratio (see below)). There entitled to 10% or more of either the are some additional requirements for dividends, the shares or the votes in the UK Group UK REITs, including submission of REIT unless the UK REIT has taken prescribed financial statements to HMRC ‘reasonable steps’ to avoid the payment of for each accounting period. such a distribution. A shareholder is not prohibited from exceeding the 10% THE OTHER ISSUES threshold, but in practice the UK REIT will Interest Cover Ratio want to avoid this additional charge. The UK REIT regime uses an interest Reasonable steps could include a cover ratio, rather than a conventional provision in the UK REIT’s Memorandum gearing ratio, in setting the limit on and Articles of Association, requiring a how much a UK REIT is able to borrow. shareholder who exceeds the 10% The limit provides stability for investors threshold to enter into a transaction and acts to prevent a UK REIT diverting designed to remove the entitlement to a substantial portion of its profits that dividend. This might be achieved by towards repaying interest and thereby a dividend strip transaction, where the reducing the amount of taxable counter-party would not be beneficially distributions. entitled to 10% or more of the dividends, The ratio must not be lower than or by the establishment of a trust to 1.25. This figure is below the industry hold the dividends unless or until the shareholder ceased to exceed the British Land has planning consent for a 10% threshold. substantial mixed use development at Regent’s Place, London NW1. www.propertyweek.co.uk The structure of a UK REIT 41

THE UK REIT REGIME AIMS TO PROVIDE A LIQUID AND “PUBLICLY AVAILABLE VEHICLE

average and is relatively modest when the regime” while inadvertent and minor compared to the 2.5 ratio that was breaches of the other conditions will included in the draft legislation in not usually lead to loss of UK REIT December 2005. status (unless the UK REIT makes Breach of the 1.25 ratio requirement persistent breaches). does not result in a loss of UK REIT status; instead the company will Capital allowances suffer a tax charge on its excess On entering the UK REIT regime, the UK financing costs. REIT will not need to claim capital allowances, as it will automatically take Development over the position it had prior to entry, UK REITs can undertake development such that no balancing adjustments are activities within their tax exempt required. The UK REIT will, however, property rental business provided that have to operate a ‘shadow regime’, they are undertaken with the intention acting as if allowances were claimed. to generate future rental income. However, where a UK REIT develops a Tax transparent vehicles including property held within its tax exempt offshore unit trusts property rental business and then It is now clear, that if a Group UK REIT disposes of it within three years of holds property through a tax completion of the construction, the transparent vehicle, such as a disposal, regardless of original partnership, its share of the property intention, may be treated as falling and income will also qualify for the outside the tax exempt property rental asset and income tests. The position is business. This will be the case, if the not clear for offshore unit trusts that cost of construction exceeds 30% of the are tax transparent for income. fair value of the land and buildings on entry into the regime or acquisition Stamp taxes (whichever is the earlier). In such cases, UK REITs will be subject to the usual the proceeds will fall into charge to tax. stamp duty land tax rules in relation to their UK real estate transactions. Breaches of the UK REIT conditions Investors will be subject to stamp duty Broadly, breach of certain of the or stamp duty reserve tax at 0.5% on Qualifying Company Conditions (being their dealings in their shares. those requiring the company to be resident in the UK, not to be an open- ISAs, PEPs and CTFs ended company, to have only one class Shares in UK REITs may be held in an of ordinary share in issue and not to Individual Savings Account (ISA), a be party to any non-commercial loans), Personal Equity Plan (PEP) or a Child will result in automatic expulsion from Trust Fund (CTF). 42 Tax implications www.propertyweek.co.uk

Tax implications

■ Greater tax efficiency is the most lauded benefit of UK REITs. Michael Cant, partner, Nabarro Nathanson and Simon Fellows report.

THE MOST EAGERLY AWAITED BENEFIT THAT REITS VEHICLE LEVEL will bring is that they will free listed property The cost of becoming a UK REIT is the requirement companies from the straightjacket of double to pay an entry charge equal to 2% of the market taxation. Currently, quoted property companies value of the assets involved in the property rental pay tax on rental income and on capital gains. business. Although UK REITs will not pay And, of course, investors then have to pay corporation tax on qualifying property rental further tax on the dividends they receive – a income or qualifying chargeable gains from the painful double-whammy that’s put the sector at tax-exempt business, profits from a non tax- a real disadvantage. exempt business will be liable. From the New Year, quoted companies that pay Owning subsidiaries will demand careful tax an ‘entry charge’ and successfully convert to REIT planning. Where property is held in a subsidiary of status will be tax exempt for both rental income a UK REIT, a gain on the disposal of shares will be and capital gains from their property rental treated as a profit of the UK REIT’s residual, non businesses; only the dividend paid to investors tax-exempt business and will be taxed at 30%. will still be subject to tax. For investors, this Capital allowances will not need to be claimed treatment makes the vehicle similar to investing in under the new regime, because UK REITs will be the direct property market. Levelling the existing, deemed to have claimed full capital allowances in vertiginous playing field into what, for listed calculating the profits of its tax-exempt business. property companies, will seem like a bowling Additional tax will be levied if a UK REIT makes green should inject greater flexibility, liquidity and a distribution to a corporate shareholder who tax-efficiency into the commercial property sector. holds or is beneficially entitled to 10% or more of These changes should, if experience abroad can be either the dividends or shares of votes unless the relied on, trigger a tremendous boost to the REIT has taken ‘reasonable steps’ to avoid such a property investment market. Let’s look more distribution. There is a limit on the level of closely at how UK REITs will be treated by HMRC… borrowing; breaches of the interest cover test www.propertyweek.co.uk Tax implications 43

and/or the 90% distribution requirement will also measure of relief under the appropriate double trigger tax charges. tax treaty. Typically, UK double taxation treaties Under an anti-avoidance provision, tax may reduce the rate of tax on dividends from UK also be levied to reverse any tax advantage resident companies to 15%. However, the taxation obtained by a UK REIT, if REIT status has been of distributed capital gains as income is used for tax planning and, in extreme or repeated particularly disadvantageous for non-UK tax instances, the company can be removed from resident investors, because they do not generally the REIT regime. pay UK tax on gains realised from a direct investment in UK investment property. DISTRIBUTIONS A UK REIT must pay distributions – called property EXEMPT BODIES income distributions (PIDs) – equal to 90% of the Exempt bodies – pension funds, charities, local profits of the property rental business. They will authorities etc – will not suffer withholding tax on generally be treated as UK property income in the PIDs. Also, because UK REITs will not be subject to hands of the shareholders for UK corporation tax tax on the profits of their tax exempt business, and income tax purposes. PIDs will be subject to these exempt bodies should not bear the ‘indirect’ withholding tax at the basic rate, currently 22%. tax cost of being unable to reclaim the tax credit There will be a withholding imposed if the PID is normally associated with distributions by UK paid to certain classes of shareholding including resident companies. UK companies, charities, local authorities and UK pension schemes. It is possible that many UK REITs will pay shareholders both PIDs and normal dividends. This is because a UK REIT that pays a distribution in EXEMPT BODIES WILL NOT excess of 90% of the profits of the property rental business may choose whether this distribution is SUFFER WITHHOLDING TAX an additional PID or a normal dividend. Due to “ the interaction of capital allowances and PIDs ON PIDS… there is likely to be an advantage in paying a normal dividend equal to at least any capital allowances due to the UK REIT. EARLY EXIT CHARGES UK RESIDENT TAXPAYERS If a company leaves the UK REIT regime within ten Distributions from a UK REIT will (at current rates) years of joining and then disposes of any property attract tax at 30% in the hands of UK corporates that was involved in” its tax-exempt business and 40% when received by higher rate income tax within two years of doing so, then any uplift in payers. An allowance will be given for any the base cost of that property which occurred on withholding tax suffered by an individual. This is entering the regime will be disregarded. This broadly in line with the rates paid by direct could result in a higher chargeable gain or lower property investors. allowable loss. Tax withheld from a PID is credited against the individual shareholder’s own tax liability, and STAMP TAXES shareholders whose rate of tax is less than 22%, UK REITs will be subject to the usual stamp duty or who do not pay tax at all, can claim the land tax rules and investors will be subject to difference from HMRC. stamp duty or stamp duty reserve tax at 0.5% on their dealings in shares. This compares favourably NON-UK RESIDENTS with the maximum 4% charge to stamp duty land Some non-UK resident investors may be able to tax applicable to purchases of UK real estates that escape the 22% withholding tax by obtaining a are held directly by the investor. 44 Sponsor profile www.propertyweek.co.uk

BRITISH LAND IS EUROPE’S LARGEST QUOTED PROPERTY company (measured by assets) investing in modern commercial properties, principally London offices and out-of-town retail – sectors highly favoured KEY INFORMATION for growth over the next five years. Its portfolio is valued at £20bn, of which £16bn is directly The British Land Company PLC owned and the balance is managed for third 10 Cornwall Terrace, Regent's Park, parties in joint ventures, partnerships and funds. London, NW1 4QP, United Kingdom In total, British Land owns or manages around Tel: +44 (0) 20 7486 4466 41m sq ft (3.9m sq m) of real estate. Fax: +44 (0) 20 7935 5552 The company’s objective is to produce superior, Email: [email protected] sustained and secure long-term shareholder www.britishland.com returns. It does this by an intense focus on meeting customer needs with prime properties in strong supply constrained locations, thereby Total One Three creating exceptional long-term investments with Shareholder year years Returns1 long lease profiles and good growth potential. It creates additional value through intense asset management and a flexible and entrepreneurial British Land 47.1% 191.7% approach to deal-doing and financing. British Land also provides shareholders with an FTSE Real 37.8% 151.2% attractive and secure stream of dividends, which Estate Index have grown at 8% compound per annum over the past five years. FTSE 100 12.5% 61.2% MARKET CAPITALISATION 1 Growth in share price plus dividends reinvested Circa £8 billion.

PROPERTY PORTFOLIO British Land is the UK’s largest retail landlord, with £13.3bn under management, which represents 62% of its portfolio. The largest part of this is in prime out-of-town locations, in retail parks and superstores. The business has also expanded into continental Europe. The £5.6bn office portfolio (also the UK’s largest) represents 35% of total assets (41% pro- forma for developments), and is focussed on central London. The company has 3.5m sq ft (0.32m sq m) of well-timed London office developments coming to fruition before 2010, including The Broadgate Tower and 201 Bishopsgate.

British Land will be a flagship of the new REIT British Land’s Willis regime offering focused real estate investment Building, a prestigious office with a pre-eminent combination of performance, development in EC3. scale and accessibility. www.propertyweek.co.uk Sponsor profile 45

NABARRO NATHANSON HAS BEEN CLOSELY INVOLVED in the development of UK REITs both at a company and sector level. It is currently advising leading names in the sector on UK REIT issues KEY INFORMATION including conversion to REIT status. Recognising the tremendous potential the Christopher Luck or Michael Cant UK REIT has for the real estate sector, it has Nabarro Nathanson, Lacon House assembled a dedicated team to advise clients on Theobald’s Road, London, EC1X 8RW these opportunities. This group includes Tel: +44 (0)20 7524 6000 specialists in real estate, corporate finance, tax Fax: +44 (0)20 7524 6524 and banking. Email: [email protected] The REIT group is led by Chris Luck, a partner www.nabarro.com in Nabarro Nathanson’s Corporate Real Estate Group. He has been actively involved in the development and the promotion of REITs within Nabarro Nathanson is a City law firm the sector, including with the London Stock with 117 partners and over 350 other Exchange. qualified solicitors. It has strong Nabarro Nathanson is well known for its work relationships with law firms overseas, in the real estate sector, including finance, particularly in Europe. funds, corporate finance, M&A, construction, planning and real estate matters. It is at the forefront of the trend for using corporate structures and techniques in real estate transactions including:

■ Real estate M&A and listings ■ Real estate funds ■ Multi-jurisdictional joint ventures ■ Investment into European and global real estate funds, and ■ Real estate taxation 46 Sponsor profile www.propertyweek.co.uk

THE LAUNCH OF REITS IN THE NEW YEAR OPENS UP A new world of opportunities for private investors interested in property. It is a world that has significant complexities and potential pitfalls KEY FACTS that must be understood and considered by the prospective investor. Reita (The Reits and Quoted But there has been a serious lack of available Property Group) and easily understandable information on REITs c/o British Property Federation – until now! 1 Warwick Row More than thirty of the UK’s leading UK London, SW1E 5ER property and financial services companies together with corporate advisers, the British Tel: +44 (0) 20 7802 0109 Property Federation, IPF and the London Stock Fax: +44 (0) 20 7834 3442 Exchange have come together to set up Reita – Email: [email protected] an education campaign to raise awareness and www.reita.org understanding about REITs, property funds and investment in quoted property companies MEMBERSHIP INFORMATION amongst investors, financial advisers and other Dave Butler ([email protected]) market influencers. Karen Tyler ([email protected]) Central to Reita is www.reita.org – an internet Tel: +44 (0) 20 7802 0109 portal providing non-partisan background information, access to expert knowledge and the latest news on companies converting to REITs (and those that won’t!) It also holds the first freely available personal taxation guide for REITs and the most recent legislation from HMRC. www.reita.org contains tools to find an adviser or broker, links to quoted property companies, providers of investment products and to sources of data in the UK and around the world. Future features, including comprehensive performance data and comparison tools, will be added as the REITs’ market develops and interest in listed property investment grows. Since its launch in August, Reita’s profile has grown, achieving 30% brand recognition amongst IFAs in just 10 weeks, and is proving an invaluable source of information for analysts, journalists and industry commentators. www.reita.org really is the one place to go to find all you need to know about REITs! www.propertyweek.co.uk Sponsor profile 47

ROTHSCHILD IS THE LEADING INDEPENDENT investment bank in the real estate sector, with coverage of corporate finance, debt arrangement and capital markets from its key centres of KEY FACTS excellence in London, Paris, New York, Frankfurt, Milan, Hong Kong and Sydney. Andrew Radkiewicz or Andrew Macland It achieves best execution for its clients by N M Rothschild & Sons Limited being active across all aspects of real estate New Court leveraged finance: senior debt, B Notes, St Swithin’s Lane mezzanine, equity underwriting and London securitisation. EC4P 4DU Rothschild draws together specialists covering the full spectrum of skill sets: pan-European Tel: +44 (0)20 7280 5750 property expertise, corporate advisory, debt Fax: +44 (0)20 7280 1918 structuring, legal, surveying, ratings and capital Email: markets. [email protected] Its innovation and client service were the [email protected] main drivers behind it being awarded the coveted European CMBS deal of the year 2005 by the leading securitisation journal, International Securitisation Report. 48 Glossary www.propertyweek.co.uk

Capital Gains Tax The tax that is payable on the profits made on the disposal of most investment products. Capital value The value of an asset, freehold or leasehold, as distinct from its annual or periodic (rental) value. Closed-ended funds Investment funds that issue a fixed number of shares, so to Glossary buy the shares there usually must also be someone wishing to sell shares. Creation price A term used in Adjusted NAV per share Net investment process, can be the UK to refer to the cost of asset value per share, adjusted a stock market index or a creating a unit, based on to add back deferred tax peer group. buying the underlying associated with investment Bid/offer spread The difference securities within a unit trust. property, together with any between the buying and selling The actual buying (offer) price accounting deficits in joint price of shares and units, is usually the creation price ventures that do not represent largely attributable to the plus the initial charge. actual liabilities. initial charge. Dilution Effect on earnings per Alternative investments Any Bid price The price at which share and book value per share investment other than equities units or shares may be bought if all convertible securities were and fixed income, such as or sold. converted or all warrants or property, private equity and Bonds Loan agreements with a stock options were exercised. hedge funds. company or a government Distribution The income Assets Any possession that has where there is an arranged or capital gain made by a a value. The investments repayment to the investor mutual fund that is paid to within a fund are assets; they when the loan matures and the fund's investors. may include shares, bonds the investor receives interest Direct property fund A fund and/or cash. throughout the life of the loan. that invests 100% in direct Basis point (bp) One hundredth Such bonds can be bought commercial property and holds of a percentage point, eg 2bp and sold. no property shares, REITs, other = 0.02%. Bulls City dealers who believe equities or other indirect Bears City dealers who think prices will rise, so they buy holdings. Authorised Property investments are going to fall, securities in the hope of selling Unit Trusts can invest 100% in so they sell their investments them at a higher price than direct properties. in the hope of buying them they paid. A bull market is any Dividend The income received back at a lower price. A bear market in which prices are in from a company by a market is a period of falling an upward trend. shareholder; a share of the stock prices, over a period Capitalisation The value of an profits made by a company of time. asset assessed in relation to that it has chosen to distribute Benchmark A target against the expected future income to its shareholders. which investment fund (rental) stream. Dividend reinvestment performance can be measured. Capital gain Arises when an Dividends that are reinvested A benchmark, usually investment is sold at a higher in the security that generated stipulated at the outset of an price than originally paid. them. www.propertyweek.co.uk Glossary 49

Dividend yield A ratio that the increasing trend towards shares. Income shares receive represents the amount of real estate investment trust all the income generated by income a company pays in (REIT) structures in Europe. the whole fund but do not dividends compared with its Fund size The total value of benefit from any increase in current share price, calculated assets under management in the value of the shares. by dividing the annual a fund. Index The indicator of the dividend per share of a Gearing The use of debt value of a sector of shares in company by its current share financing. The debts of a a market. The most common price. The ratio does not take company expressed as a index in the UK is the FTSE 100 into account capital gains percentage of its equity capital. which is an indication of the or losses associated with If a fund is geared it means performance of the top 100 the stock. that it has the ability to (by market capitalisation) UK Dividend cover Number of borrow money and therefore companies' shares. times dividend charge in the take advantage of greater Indirect property fund A fund profit and loss account is investment opportunities. that invests in indirect property covered by profit after tax. Gilt edged security Gilts vehicles, such as property Earnings per share (EPS) Profit are bonds issued by the UK shares, property investment after taxation divided by the Government which pay a fixed companies, REITs, limited weighted average number of rate of interest for a set period partnerships or property unit shares in issue during the year. of time. At the time of trusts, as opposed to holding Estimated rental value (or purchasing the bonds the direct commercial property rental value) (ERV) The rent purchaser knows the income in its portfolio (direct that a property might that will be received over the property fund). reasonably be able to life of the bond. Initial public offering (IPO) A command in the open market Gross fund A fund which does company's first sale of stock to at a given time, subject to the not pay corporation tax or any the public. terms of the relevant lease. other type of tax on income or Investment property Financial Services Authority capital gains, eg pension funds. Any property purchased (FSA) The main financial Growth fund A fund whose with the primary intention services regulatory body in the main objective is capital of retaining it and enjoying United Kingdom. FSA is the appreciation. Contrasts with the total return (rental income designated agency under the an income fund where the and appreciation in capital Financial Services and Markets main aim is to provide higher value) over the life of the Act 2000 and the regulator of than average income in the interest acquired. exchanges, clearing houses, form of a dividend payment. Investment trust A company recognised professional bodies, Hedging A transaction that whose sole function is to banks, wholesale money reduces the risk of an invest in the shares of markets and certain investment, or protects an other companies. investment businesses. existing position or Liquidity In a property context, Flat yield The most commonly commitment, by using one type this refers to the ability to used yield calculation, which of investment (eg a future or readily convert an asset or divides the annual income paid option) to cover adverse investment to cash by sale at by the market price. market movements. a fair price. Also used to FTSE/EPRA NAREIT An index Income shares Some describe the amount of cash created to track the investment trusts, called split- held in a portfolio. performance of listed real capital investment trusts, issue Listed firm/company A estate companies and REITs more than one type of share. company whose stock trades on worldwide which allows The simplest 'split' is divided a stock exchange (also called a investors to take advantage of between capital and income quoted company). 50 Glossary www.propertyweek.co.uk

Market capitalisation Retail sector (property) shares are often traded on the The total value of a company's Sector of commercial property stock market, which are set stock; a measure of corporate including high street shops, up as a way to help new size. shopping centres and retail enterprising schemes and Net asset value (NAV) The total warehouses. companies to get started, assets of a company less all Return The amount by which or established ones to expand its liabilities including loan an investment may change (these are known as unquoted capital, and preference shares. due to a combination of companies). Due to the NAV is usually expressed on a capital growth and/or interest uncertainty involved when per share basis. dividend income. This is investing in unquoted Net asset value (NAV) per share normally expressed as companies, the returns can Equity shareholders' funds a percentage. be substantial but so can divided by the number of Revenue profit Profit before the losses. shares in issue at the period tax, excluding the impact of Yield The amount of income end. exceptional costs or profits generated by a fund's Open ended investment including bid costs, FRS3 investments in relation to company (OEIC) A UK open- profits, interest charges on the price. It is usually quoted ended collective investment termination of financial gross (ie before tax and scheme with variable capital, instruments and group after charges). which is structured as a reorganisation costs. Yield hardening/softening company rather than as a unit Rights issues Further issue of The movement of yields trust. They were launched in shares by an existing company (usually, but not always, the UK in 1997. to raise funds. Shares are referring to equivalent yields) Price/earnings (P/E) ratio offered to existing shareholders over a period of time. A The share price of a company who can sell the right on to hardening of yields refers to divided by its earnings per other people. yields falling (ie capital values share. The price earning ratio Securities Another name for are rising) while a softening is usually used for comparing stocks and shares; also applies refers to yields rising (ie capital companies' investment to any approved or registered values are falling). potential. financial instrument, such as Property income distribution unit trusts. (PID) Distributions paid by a Securitisation A financing REIT to shareholders. technique where the income Regulated unit trusts Those stream of an asset is used to trusts that can be marketed service the interest and freely in the UK. Any trusts principal repayments on the based in the UK that are relevant debt instruments. authorised by the FSA; overseas Unit trust A system where trusts have to be recognised money from a number of by the FSA. investors is pooled together REITs (Real Estate Investment and invested collectively in Trusts) A method of indirect investments such as shares and property investment, where bonds. Each investor owns a distributions are made tax unit (or a number of them), free, and which are taxed the value of which relates to according to the tax status of the value of those items owned the shareholders. Due to be by the fund. introduced to the UK in Venture capital trusts January 2007. Investment trusts, whose REITs, the waiting is almost over!

We have been closely involved in the development of the REIT legislation in the UK and are advising a number of companies on their conversion to a REIT. We are a City law firm with real strength and depth in the real estate, corporate and finance sectors.

To take advantage of our experience or to find out more, please contact: Christopher Luck or Michael Cant on +44 (0)20 7524 6000, or email [email protected]

www.nabarro.com