Residential REITs (Real Estate Investment Trusts)
There’s been increasing reference to Real Estate Investment Trusts (REITs) in the housing press. Here’s a short guide to what they are and the legislative changes that are anticipated to make them more housing friendly.
In 2007, REITs were introduced as a tax-efficient method for individuals and institutions to invest in residential and commercial property collectively, with liquidity provided by the investments being quoted on a recognised Stock Exchange. Existing property investment companies were able to convert into a REIT, although there was a tax charge on conversion. Some commercial property companies such as British Land plc made the change. However, no residential REITs were formed.
The key benefits of a REIT are that, providing that 75% of the investments are in qualifying property, it does not pay any capital gains tax or corporation tax but must distribute 90% of its net income to its investors who then pay tax on that income at their marginal rate of tax. Hence, a REIT investment is tax free for eligible bodies such as pension investors and suitable for individuals to hold within an ISA or similar.
There are a number of requirements on how long monies can be held before they are invested and the degree of gearing that is acceptable for a REIT. None of these would be regarded as particularly onerous for a residential REIT.
Some of the reasons that residential REITs have not been attractive enough to set up so far are:
- the impact of stamp duty when purchasing a portfolio of residential property
- difficulties in putting together a portfolio within the required time
- the costs of conversion
- the high costs of raising funds
- compulsory listing on the main market of the London Stock Exchange.
In 2010, a consortium of housing associations looked at setting up a residential REIT, particularly to hold the unsold equity in shared ownership properties. However, ‘lack of co-operation from HMRC’ about whether these would be eligible investment properties or treated as a trading activity, as well as cost issues, stopped this from proceeding.
Most of the main issues, other than those concerning the tax status of shared ownership properties, are being addressed in the draft 2012 Finance Bill. This should become law in autumn 2012. When a REIT purchases a portfolio of residential properties stamp duty will be calculated on an individual unit basis; the listing will take place on a junior exchange such as the AIM market or Plus-SX market and the conversion tax charges have been dropped.
A consultation paper covering the impact of the proposed changes on social/affordable housing was issued jointly by the Treasury and CLG in late April 2012 with the consultation period closing at the end of June. Submissions are still being made about the status of shared ownership; it would be a considerable bonus if unsold tranches of shared ownership properties are deemed eligible for REITs to invest in in the future.
To attract investors, a REIT would have to achieve an initial distributable yield of at least 4% increasing by inflation. This, at an estimated annual inflation rate of around 2% per annum, would be slightly in excess of the yield on long-term housing association bonds which currently is between 5% and 5.25%. Also, although a REIT is not for a fixed term, it is tradable on a market and asset-backed by property (rather than secured).
The most obvious type of housing where this level of return could be achieved is market rent. Where individual housing organisations or consortiums acquire/develop housing for sale as part of the mixed tenure on schemes which include social rent, affordable rent and shared ownership, the structure of a residential REIT could be a suitable vehicle. The development of housing for sale properties entails a significant risk in terms of carrying the financing of the development and the timing/exit price on disposal. If a funded REIT was in place, this would give more certainty to the development funding, the timing and amount of the output price while also obviating the need to offset risk through joint ventures. Potentially some of the costs associated with disposal would also be reduced. The overall benefit would be to give more certainty and de-risk the private sale element of the development programme.
The launch of a REIT to hold social or affordable housing for rent will hinge completely on the level of return that can be achieved from those types of properties. At least two consortiums have indicated that they hope to set up a residential REIT for properties with these tenure types. Let’s see what unwinds once the new bill receives Royal Ascent …
If you would like to discuss any aspect of REITs further then please contact Susan Kane on 07870 685 891 or email@example.com