Real Estate Investment Trusts (REITs)

February 2006

At last, after many years of lobbying, draft legislation for Real Estate Investment Trusts, or "REITs" is eventually on the table with an expectation that they will arrive on 1st January 2007. Although the draft legislation does not address the issue, it appears that REITs will be eligible investments for ISAs, PEPs and Child Trust Funds, and whilst the taxation proposals will need some careful consideration, there may be benefits to be derived over and above those available from investing in property through Non UCITS Retail Schemes (NURS).

The draft legislation, though not finalised, provides a good idea of what will be required to qualify as a REIT.

Effectively REITs will be another form of UK authorised investment trusts. They will be required to be established as UK resident companies and to be listed on a recognised stock exchange. In addition, no one shareholder (whether an individual or corporate shareholder) will be permitted to own more than 10% of the company.

To qualify, REITs will need to hold at least three properties, with no one of those being valued at more than 40% of the value of the total property portfolio with a property being classed as a single property if it is designed to be rented out as single commercial or residential units providing scope for large shopping centres, for example, to be a stand-alone REIT.

From an operational taxation perspective REITs will be required to have two distinct components:

1. a tax exempt property letting business from which it will be required to derive at least 75% of its total profits and which must account for at least 75% of its gross assets; and

2. a taxable business that would derive income from ancillary property services and associated development.

In addition to these and some detailed requirements for distributions of both dividends and capital gains, certain other financial conditions and requirements will be imposed on REITs which should be noted, including:

• A borrowing limit, based on interest cover and not asset value;
• The requirement to pay a tax charge on the excess interest in the event that the profits on the tax exempt portion of the business are less than 250% of the interest bill; and
• The requirement to distribute 95% of the profits of the tax exempt business by way of dividend within 6 months of the end of its accounting period.

Despite the potentially complex taxation position and specific concerns surrounding the listing requirements and shareholder restrictions REITs look set to open some new investment opportunities when they are introduced in January 2007 and as such should receive a cautious welcome from the industry.

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