Property

A new addition to the mix

The UK Government is in the process of initial consultations about the potential introduction of Real Estate Investment Trusts. Janet Measom, property product specialist at Morley Fund Management, highlights the main points surrounding these consultations and discusses how the new vehicles will offer choice and flexibility to investors

Over the last few months, the expression "Reit" has started to creep into the arcane vocabulary of the UK financial services industry. But what does it mean? Like so many of the acronyms employed – Oeics, Ucits, Sicavs and so forth – this is far from immediately obvious to the lay person.

Reit stands for Real Estate Investment Trust and is a way of investing in property – potentially residential as well as commercial – through a securitised, typically closed-ended and entirely tax-transparent vehicle that distributes a high percentage of its income and is capable of being listed on a stock exchange. At the moment the UK is alone among the world's seven richest nations in not offering a Reit-type vehicle although this is about to change.

So when might we see Reits in the UK? In his 2004 Budget, Chancellor Gordon Brown announced the start of a consultation process regarding the potential introduction of Reits into the UK. The initial consultation process ran through to July 2004, with the hope that Reits would go live in the 2005 Budget – however, it is now apparent this will not happen until 2006 at the earliest.

Following various industry submissions, the Government has outlined its most recent thoughts in a second discussion paper published as part of the March 2005 Budget and has invited further comment.

With regard to the actual characteristics of a UK Reit, the main areas where some sort of resolution has now been achieved include:

Name: The Treasury suggested that an alternative name – "Property Investment Funds" was one that was mooted – would be more meaningful to the UK investing public. However it has decided to stick with Reits.

Structure: It looks very probable that Reits will be closed-ended funds. Open-ended property funds are part of a separate consultation exercise.

Definition: A Reit will be required to have at least 75% of its activity in "ring-fenced" property letting business.

Development activity: This will be part of the 25% non-letting restriction.

Geography: UK Reits will be able to invest anywhere in the world.

Type of property: Any type of property will be permitted.

Management: This may be internal or external.

Diversification: There is likely to be a permitted maximum proportion of the fund in any one property.

Holding periods: There will be no minimum holding period.

Taxation and stamp duty: Income within the ring-fenced activity would be exempt from corporation tax while transfers of interests in a UK Reit would be subject to stamp duty reserve tax of 0.5%, just like an authorised property unit trust or property company share.

On the other hand, areas that are still to be resolved include:

Listing: There are arguments for and against listing although most industry commentators believe listing should not be compulsory.

Gearing: The Treasury is concerned too much gearing would lead to unreasonable levels of risk within the funds. The investment industry, however, would generally prefer less regulation in this area.

Taxation: How will non-UK taxpayers be taxed?

Conversion charges: There has been little or no indication as yet as to what the costs of converting to a Reit might be and on what they will be based – for example, a percentage of value or of unrealised capital gains – and how these will apply to different vehicles looking to adopt Reit status.

There is a wide divergence of views as to whether Reits will radically change the UK commercial property market or whether they will turn out to be something of a damp squib. At the moment interest in property is at an all-time high and new and innovative ways of accessing the market appear to be coming from all directions.

Buy-to-let investment clubs, residential property in self-invested personal pensions, the Opromark scheme that effectively creates a "stockmarket" for property, Eastern European residential funds and the use of property derivatives are just some examples.

It is too early to say just how much impact Reits will have as this will depend on how the legislation pans out and also on what conversion charge is attached to switching to a Reit structure. If the Treasury exacts too high a price, then all the hype could come to very little.

However, Reits undoubtedly have the potential to add to the choice of property investment vehicles available and should offer opportunities for flexibility that have not hitherto existed in the UK. There is cause for optimism that UK Reits will become a significant part of the property investment market.