Summary and implications
The Finance Act 2012 has implemented a number of changes to the REIT regime. The most important changes are as follows:
- The two per cent entry charge payable by a company on joining the REIT regime has been abolished.
- Companies that are trading on AIM or similar markets can convert to REIT status.
- The diverse ownership requirement has been relaxed, allowing a company to convert to REIT and then seek to widen its shareholder base over a three-year period.
The diverse ownership requirement has been relaxed, allowing a company to convert to REIT and then seek to widen its shareholder base over a three-year period.
Main changes
The two per cent entry charge calculated on the market value of a company's properties has been abolished. Previously, this upfront charge was a significant barrier for investment vehicles with extensive property portfolios.
The requirement for a main market listing has been relaxed to allow for AIM, Plus and foreign equivalent listing. This change will lower the cost and compliance burden of the REIT regime.
Companies seeking to convert to REIT status now have a three-year grace period from conversion to meet the non-close company requirement. Previously, REITS were prohibited from being close companies (basically controlled by five or fewer people). This change will allow closely held companies to become REITS provided they widen their shareholder base within the permitted three-year period. The change also allows a REIT to ignore shareholders who are "institutional investors", namely authorised unit trusts, OEICs, pension funds, insurers and those benefiting from sovereign immunity, in deciding whether it is close.
Cash and gilts are in future to be treated as "good assets" for the purposes of the balance of business test. Under this test at least 75 per cent of a REIT's total assets must relate to its property rental business.
Finally the definition of "financing costs" has been changed for the purposes of calculating the financing cost ratio. Only loan interest will now be used when calculating the interest cover of a REIT.
Why have these changes been made?
The principal aim of the REIT regime is to provide a tax efficient vehicle which encourages investment in the property sector. As of September 2012, 25 UK REITs have been created which are primarily focused on commercial property investment.
The stated aim of the new measures of the REIT regime is to address barriers to entry and investment in the regime and reduce the costs of complying with the requirements of the regime. The changes should therefore facilitate increased investment in REITs.
Will the changes result in more REITs?
Some commentators have suggested that there will be a wave of REIT conversions or the creation of new REITs. The argument goes that there is, for instance, a lot of property held offshore that will now, following abolition of the entry charge, be able to establish itself as a REIT without cost. The counter-argument is that it is only worth incurring the costs of conversion, both professional and those of listing, if this affords an exit for an existing investor. So far there has been no rush of companies to convert post the changes.
What is the effect of these changes?
In March of this year, the Government undertook a consultation on REITs. The consultation looked in particular at the role that REITs can play in supporting the social housing sector and secondly, the tax treatment of REITs investing in REITs. The first aim of the consultation is to examine how REITs could be used to support the social housing sector and address the Government's overarching aim of securing additional private finance to fund the development of new social housing. The consultation also looked at the opportunity for REITs to invest in REITs resulting in additional tax benefits for investors and allowing for greater investment diversification. This would be a significant step away from limiting REIT activity to direct investment in property. The consultation closed on 27 June 2012, so far nothing further has emerged.
Conclusion
The scope of the regime has been widened allowing for increased accessibility. It remains to be seen whether the effect of these changes will result in a wave of new REIT conversions and creations and increase more innovative investment into new sectors.
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