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Reits ahead

Open-access content 9th March 2007

09 March 2007

The first day of January 2007 was an important date for the UK real estate industry. It marked the beginning of the new UK regime for real estate investment trusts (Reits). Nine leading companies converted on New Year's Day and more are set to follow as well as new flotations. But what is a Reit and how might they affect facilities managers?

What is a UK Reit?
Reits were introduced by legislation in the UK in 2006 and must be publicly quoted companies. A Reit is a property investment company. It is not a new form of corporate vehicle and does not change property law or ownership. A UK resident company can elect to join this tax regime by notice to HM Revenue and Customs. As a consequence it will not be taxed on rental profits or gains.

The key conditions for Reit status are:
 -Reits must be UK tax resident and listed on a recognised exchange. This includes a UK listing but does not include the London Stock Exchange's Alternative Investment Market (Aim)

-A Reit must have or acquire at least three properties and a single property must not represent more than 40 per cent of the total value of the investment portfolio
n 75 per cent or more of the income and assets should be derived from a Reit's property rental business. The income is 'schedule A' rental income for tax purposes 

-Income from other sources such as trading and services will be outside the 75 per cent tax exempt business and will be taxable in the usual manner. Facilities management services will therefore be permitted within a Reit but will be part of its taxable residual business

-Development for investment purposes is permitted within the tax exempt business

-At least 90 per cent of the net income profits of the property investment business must be distributed as a property income distribution (Pid) to investors within 12 months of an accounting period

-Profits on other activities in the residual business, such as facilities management services are taxed and distributed as for other companies

-Investors are taxed or exempt on distributions by a Reit according to their tax positions. The Pid is treated separately from other distributions

-A company converting to Reit status is required to pay a 2 per cent entry charge on the market value of its real estate portfolio

-Reits may borrow, subject to an income to interest ratio test of 1.25 times

-Reits cannot include their own occupied property in their tax exempt business

Why seek Reit status?
Conversion has been attractive to listed property companies because Reits are increasingly becoming the vehicle for listed property investments across the globe. This is partly due to their exempt tax position, distribution requirements and consequent closer resemblance to their underlying real estate assets. In addition, conversion allows UK companies to eliminate unrealised capital gains tax charges on their underlying property.

Reits are also more liquid for investors because they are listed and shares may be freely disposed of or acquired on the secondary market. Reits may also seek to access capital from the broader market.

In addition to lower taxation within the Reit itself, Reits are required to distribute at least 90 per cent of their income as a Pid. As a result, Reits may be attractive to investors seeking both an income yield and the potential for future capital growth. A 22 per cent tax withholding applies to a Pid with a UK investor being taxed at its marginal rate on the balance. If the investor is tax exempt or any other relief applies, it should be able to reclaim all or some of this. Overseas investors may be able to reclaim tax withheld under applicable double taxation treaties.
A Reit can also be included within an individual savings account (Isa) or self-invested pension plan (Sipp).

Impact of Reit on FM
Income from the investment activities and good tenant relations are very important for Reits. This is not exclusive to Reits but Reits do have a particular interest. Property occupiers are increasingly considering their property portfolios and whether they should continue to be owner-occupied or sold to realise cash for investment or investors. The property would then be leased back.
Efficient facilities management for maintaining good tenant relations is very important in a Reit world. This can be done internally by a Reit or independently alongside a Reit or in a joint venture. In this regard Reits create great opportunities for facilities management.

Facilities managers may bid for large management contracts alongside Reits or become part of a Reit's overall business. Whether Reits and facilities managers converge or maintain independence remains to be seen. However, it is clear that facilities management services alone cannot constitute a Reit given their predominant relationship with property investment. Outsourcing can still be within a Reit provided the 75 per cent assets and business conditions can be met on rental components of the relationship.

The future of Reits
It has been predicted that the UK Reit market could easily grow to a market cap of £100 billion in five years. The market is at a very early stage and still developing new funds, takeovers and substantive real estate transactions are all likely to follow. UK Reits may follow the US market and become increasingly specialised by market sector to cater for the needs of investors who want to select property shares by sector type.

Christopher Luck (partner, corporate real estate) and
Winston Penhall (junior associate, corporate real estate)
are with Nabarro

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