Post-Brexit legislative changes could prove a pivotal turning point for private equity real estate (PERE) managers in the UK. Brought into effect in April 2023, these changes have enabled private real estate investment trust (REIT) structures. REITs, previously required to be publicly traded, are widely recognised and accepted by international institutional investors and offer a structure for holding real assets with diversification and taxation advantages.
Given these benefits, what should PERE managers consider when thinking about establishing a REIT structure in the UK? This article summarises the background of the regulatory changes, the requirements managers must meet to achieve and maintain REIT status, and the key factors to address when reorganising assets into a REIT structure.
The background: regulatory changes and the introduction of institutionally owned private REITs
In the UK, a REIT is a company limited by shares that invests in real estate assets and carries on a property rental business, or a group of such companies. The rules for REITs were introduced in the Finance Act 2006 and came into force on 1 January 2007. REITs are exempt from UK corporation tax on income profits and capital gains, meaning the tax impact on investors is similar to making direct real estate investments. As tax is levied at the shareholder level, tax-privileged institutional investors can claim exemptions on property profits received from an UK REIT.
These tax benefits saw large institutions increase their investments in UK REITs, and consequently aspects of the regulatory regime, which was initially written with retail investors in mind, became outdated. In 2012, changes to REIT regulations were introduced that relaxed the listing requirements, allowing AIM listing, reducing costs and providing flexibility; as well as relaxing the diverse ownership condition for when there are institutional shareholders.
Listing requirements for REITs were then amended in 2022, removing the requirement for shares to be admitted to trading on a recognised stock exchange in cases where institutional investors hold at least 70% of the REIT’s ordinary share capital.
It is important to note that an authorised unit trust, an open-ended investment company or a collective investment scheme limited partnership that meets a genuine diversity of ownership test is itself an institutional investor for the 70% test. This opens up attractive options for structuring funds. For example, a private REIT owned by a limited partnership fund provides a very flexible fund vehicle. These have been used in the U.S. for a long time and we are now starting to see these in the UK following the 2022 changes.
In effect, this rule change gave the green light to institutionally owned private REITs, providing PERE investors with a structure that is well-understood and offers attractive tax benefits to UK and international institutional investors, many of whom have pools of capital dedicated to REIT investments. As well as opening up fundraising options, private REITs offered PERE firms a potential new stream of deal flow as listed REITs were trading at deep discounts to NAV and could potentially be taken private.
How it’s done: the requirements to achieve and maintain REIT status
PERE managers exploring the possibility of using a REIT need to be aware of the conditions that must be met for a company to qualify and remain within the regime. These include:
- Listing requirements: A REIT must be admitted to trading on a recognised exchange, except where institutional investors hold at least 70% of the ordinary share capital in the REIT principal company
- Close company requirements: The REIT principal company must not be a close company, meaning it must be controlled by more than five participants, unless it has one or more qualifying institutional investors as participators
- Distribution requirements: The REIT must distribute 90% or more of its tax-exempt income profits by the filing date of its tax return
- Property rental requirements: The REIT must hold at least three properties, with no single property exceeding 40% of the total value of properties in the rental business. An exception to this came into force in April 2023, whereby a REIT can hold a single property provided it is a commercial building with a minimum value of £20m
- Balance of business requirements: At least 75% of the REIT’s gross assets and accounting profits must relate to the property rental business
What to think about: considerations for reorganising assets into REITs
With the UK corporation tax rate increasing to 25% from 19% in April 2023, the REIT wrapper and its tax-efficient nature has become an attractive option for PERE managers. Many are looking at reorganising existing UK portfolio assets into a REIT held by the fund.
A reorganisation process can be resource-intensive and requires careful thought. There are five key factors that we think should be considered during the planning process:
Managers should take advice to ensure that the REIT wrapper is appropriate in the context of existing fund structures, assets held and investor requirements. Managers should take appropriate legal and tax advice to ensure any potential structuring issues are addressed within an appropriate timeline whilst being as cost-efficient as possible.
2. Due diligence
Any third-party consents required to implement a reorganisation process or whether there are any holders of excessive rights should be identified as part of a legal due diligence process. For example, investor or joint venture partner consent may be required, or, where a REIT might face a penalty charge for paying a dividend to a holder of excessive rights, a fragmentation of investor interests may be necessary.
3. Investor engagement
Investors should be consulted to ensure that any required consents and fragmentation of shareholdings above 10% identified as part of the due diligence process are agreed, and that any internal or regulatory requirements they have are incorporated into the reorganisation plan.
The timing of this is important; it should be early enough in the process to ensure considerations can be incorporated, but it should be done only after a detailed, properly considered plan can be presented in the first instance.
Current valuations and up-to-date accounts need to be completed with relevant valuation agents in order to minimise any delay in the reorganisation process.
5. Project management
A major contributor to a smooth transfer of an existing asset(s) into a private REIT is the alignment and coordination of advisers and third parties. Leveraging an administrator that offers a full suite of administration and investor services can remove sticking points throughout the process.
6. Regulation and governance
Typically, private REITs or the funds that hold them are externally managed by an investment manager and therefore regulated under the UK’s post-Brexit continuation of the EU’s Alternative Investment Fund Managers Directive (AIFMD). Attention needs to be given to regulation and strong corporate governance is crucial. To this end, it is important to note that the Financial Reporting Council (FRC) is in the process of updating the UK Corporate Governance Code 2018, bringing a much greater focus on financial controls.
A bright future
Private REITs offer some hugely exciting possibilities for PERE investors in the UK. Managers can now offer both domestic and international institutional investors a highly tax-efficient, well-understood structure that may prove a boost for fundraising after a challenging period. Enabled by legislative changes designed to make the UK more globally competitive post-Brexit, strong uptake of private REITs could lead to the country being seen as the domicile of choice to structure and hold institutional real estate assets.
A private REIT is also a very good stepping stone to a full IPO and main market listing for the REIT later. Assets can be acquired in the private format and scale built with the IPO taking place at the optimum time in the market.
Speak to IQ-EQ
At IQ-EQ, our team of in-house real estate experts have extensive experience of assisting clients with launching and operating a broad range of private asset funds including real estate, infrastructure as well as publicly listed REIT structures. IQ-EQ supports 300+ real estate clients with more than $150bn in real estate assets under administration. We offer a one-stop solution encompassing regulatory compliance, corporate secretarial, fund administration/accounting, AIFM, directorship, SPV and depositary services for real estate and institutional investors.
Whether you are establishing a private fund, listed REIT, or are looking at restructuring existing assets and potential new investments into a private REIT, we can ensure enhanced communication and reduced friction throughout the process. Get in touch to discuss in more detail how IQ-EQ can help: