International Bar Association Conference Real Estate
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Transcript International Bar Association Conference Real Estate
International Bar Association Conference
Real Estate Investment Trusts
Panel 3 - REIT Operating Considerations
17 October 2007
Singapore
REIT Operating Considerations - Panellists
Jerry Koh, Partner, Allen & Gledhill LLP (Chair)
Michael Blair, Partner, Mayer Brown LLP
Blair Cowper-Smith, Partner, McCarthy Tétrault LLP
Pieter de Ridder, Partner, Loyens & Loeff
Scott Newman, Partner, K&L Gates
John Sullivan, Partner, Mallesons Stephen Jaques
Yap Chee Meng, Partner, KPMG
1
Discussion topics
Tax treatment
Investment restrictions
Financing
Financial engineering
Accounting
Governance framework
2
Tax treatment
Panellists: Pieter de Ridder & Scott Newman
How is the income derived, and the distribution made, by a REIT
taxed in the different jurisdictions, in terms of withholding taxes,
dividend/distribution taxes or any taxes payable by the recipients?
Are there any jurisdictions which are particularly attractive from a
cross-border perspective in Asia or other parts of the world?
3
Tax treatment - General
Tax position of dividend and rental income earned by the REIT
Are expenses incurred by the REIT tax deductible
Gains derived from the sale of assets taxable or non-taxable
Stamp duty/transfer taxes on the acquisition and sale of property
or shares
Withholding tax suffered on overseas income earned by the REIT:
cost of business or can it be credited
Withholding tax on distributions made by the REIT
4
Tax treatment – United States
At least 95% of REIT’s gross income must be derived from:
Dividends
Abatements and refunds of taxes on real property
Interest
Rents from real property
Gain from the sale or other disposition of stock, securities and real
property (including interests in real property and interests in
mortgages on real property) which is not “dealer” property
Income and gain from foreclosure property
Amounts (other than amounts the determination of which depends
in whole or in part on the income or profits of any person) received
or accrued as consideration for entering into agreements (i) to make
loans secured by mortgages on real property or (ii) to purchase or
lease real property (including interests in real property and interests
in mortgages on real property)
5
Tax treatment – United States
At least 75% of the REIT’s gross income is derived from:
Rents from real property
Dividends or other distributions on, and gain from the sale or other
disposition of transferable shares (or transferable certificates of
beneficial interest) in other REITs
Abatements and refunds of taxes on real property
Interests on obligations secured by mortgages on real property
Gain from the sale or other disposition of real property (including
interests in real property and interests in mortgages on real
property) which is not “dealer” property
Income and gain from foreclosure property
6
Tax treatment – United States
At least 75% of the REIT’s gross income is derived from (cont’d):
Amounts (other than amounts the determination of which depends
in whole or in part on the income or profits of any person) received
or accrued as consideration for entering into agreements (i) to make
loans secured by mortgages on real property or on interests in real
property; or (ii) to purchase or lease real property (including
interests in real property and interests in mortgages on real
property)
Qualified temporary investment income
7
Tax treatment – United States
At the close of each quarter of the taxable year
A.
At least 75% of the value of the REIT’s total assets is represented
by real estate assets, cash and cash items (including receivables)
and Government securities; and
B.
(i) Not more than 25% of the value of the REIT’s total assets is
represented by securities (other than those includible under
(A) above);
(ii) Not more than 20% of the value of the REIT’s total assets is
represented by securities of one or more taxable REIT
subsidiaries; and
8
Tax treatment – United States
At the close of each quarter of the taxable year (cont’d)
B.
(iii) Except with respect to a taxable REIT subsidiary and
securities includible under (A) above:
(I)
Not more than 5% of the value of its total assets is
represented by securities of any one issuer;
(II) The REIT does not hold securities possessing more than
10% of the total voting power of the outstanding
securities of any one issuer; and
(III) The REIT does not hold securities having a value of
more than 10% of the total value of the outstanding
securities of any one issuer
9
Tax treatment – United States
The REIT must distribute at least 90% of its real estate
investment trust taxable income (as defined) for the taxable
year
Ability of REIT to designate dividends as long-term capital
gains dividends
Many REITs distribute far more than their real estate
investment trust taxable income, with the result that much of
their dividends may very well constitute return of capital
distributions
10
Tax treatment – United States
REITs can engage in hedging transactions to the extent that such
transactions hedge any indebtedness incurred (or to be incurred)
by the trust to acquire or carry real estate assets, provided such
transactions are clearly identified as such on or before the close
of the day on which it was acquired, originated or entered into.
Thus, hedging gains generally do not enter into the determination
as to whether the REIT satisfies the 95% and 75% gross income
tests
11
Tax treatment – United States
Taxable REIT subsidiaries can be used to perform activities that
cannot be conducted by the REIT itself (e.g., the provision of
“impermissible tenant services”). However, corporations that
directly or indirectly operate or manage lodging or health care
facilities, or provide any person rights to any brand name under
which such facility is operated, cannot be taxable REIT
subsidiaries. Certain exceptions to the foregoing rule apply,
however, where a lodging facility is operated by an independent
contractor
12
Tax treatment – United States
No limit on the ability of a REIT to invest in foreign real estate
However, it is unclear whether exchange gains constitute
qualifying income for purposes of the 95% and 75% gross
income tests
REITs generally will not be able to claim a foreign tax credit for
foreign income taxes incurred, nor can they pass-through foreign
tax credits to their shareholders
13
Tax treatment – United States
Dividend distributions by a US REIT to foreign shareholders are
generally subject to a 30% US withholding tax unless an
applicable treaty applies
Under the existing US-Canada Income Tax Treaty, the US
withholding tax on dividend distributions from a US REIT are
reduced to 15% where such dividends are beneficially owned by
an individual holding an interest of less than 10% in the trust; in
all other cases, the withholding rates otherwise applicable under
US law apply
14
Tax treatment – United States
Under the Protocol to the US-Canada Income Tax Treaty, signed
on September 21, 2007, the 15% US withholding rate will apply if:
the beneficial owner of the dividends is an individual holding an
interest of not more than 10% in the REIT;
the dividends are paid with respect to a class of stock that is publicly
traded and the beneficial owner of the dividends is a person holding
an interest of not more than 5% in any class of the REIT’s stock; or
the beneficial owner of the dividends is a person holding an interest
of not more than 10% in the REIT and the REIT is diversified
A foreign person is not subject to US income tax (including
withholding taxes imposed under Internal Revenue Code section
1445) on the sale of the stock of a US REIT if such stock is
regularly traded on an established securities market and such
person has not generally held at any time more than 5% of the
class of such stock
15
Investment restrictions
Panellists: Blair Cowper-Smith, Scott Newman & John Sullivan
Why do REITs need to have investment restrictions and what are
common examples of these?
What is the approach towards development and joint ownership
of assets?
16
Investment restrictions – Asia Pacific
Regulatory Requirements
Hong Kong
Singapore
Australia
Generally
50% +
Investment in property
development allowed
(10%)
(10% including
development activities
within REIT)
(For properties
to be held by
REIT)
Development activities
allowed within REIT
For properties to be
held by REIT
Within stapled
vehicle
Overseas investment
allowed
Partial ownership of
properties
(10% including
investment in property
development
Investment outside real
estate allowed
(Subject to 25% cap)
17
Investment restrictions – North America and Europe
Regulatory Requirements
US
Canada*
(25% Asset Test)
No restrictions, but subject
to 75% Asset Test and
25% Asset Test
(No restrictions if investment
otherwise permitted)
Investment in property
development allowed
(Subject to 75% Income
Test and 95% Income
Test)
(Cannot “trade” in properties
and subject to Declaration of
Trust)
Development activities
allowed within REIT
(Subject to Asset and
Income Tests)
Investment in raw land
usually limited to 15% of
gross book value
Investment outside real
estate allowed
No limits, subject to Asset
and Income Tests
(May invest in mortgages)
Overseas investment
allowed
Partial ownership of
properties
*Cannot hold hotels or retirement
homes due to impurity of income
stream
18
Investment restrictions – Canada
REIT must qualify as a “mutual fund
trust” (“MFT”)
MFT status depends on being widely
held and activity of the REIT being
limited to holding or managing real
property that is capital property of the
REIT
Trust-on-trust structures and similar
arrangements
Public REIT (“MFT”)
must be passive
Distributions or
interest
Real estate
investments held in
Sub’s or
partnerships that are
not MFTs
19
Investment restrictions – Canada
2007 new distribution tax introduced on income trusts
Safe harbour for REITs:
REIT must not hold non-portfolio property (shares or ownership
interests in other entities that exceed certain value thresholds)
other than “qualified REIT properties” which essentially means real
property that is capital property
At least 95% of its income must be from property
75% of its income must be from real property in Canada
75% of its assets consists of real estate situated in Canada
20
Investment restrictions - Trends
Cross-border REITs
•
•
Most jurisdictions now allow overseas investment
A strong trend driven by stable capital markets and scarcity of local
property (e.g. Singapore, Australia)
Development and internalised management
•
•
•
•
Attitudes to development exposure vary between jurisdictions
Move to internalised management in more mature markets
Stapled structures – investors own the manager/developer
Risk/return increase by including operating business
Broader asset classes
•
•
Hotels, retirement villages, leisure etc
Toll roads, tunnels and other infrastructure
21
Financing
Panellists: Michael Blair, Blair Cowper-Smith & John Sullivan
What are the common ways to raise finance in the various
jurisdictions - equity, debt (secured/CMBS, unsecured,
convertibles/exchangeables), hybrids, derivatives?
Are there any gearing or leverage limits imposed by the
regulators?
22
Financing – United States
No statutory or regulatory limits on leverage
Limits may be imposed by indentures, lenders and credit rating
agencies
Common REIT capital raising:
Common Stock
Preferred Stock (perpetual or convertible)
Debt Securities (senior unsecured, CMBS, mortgage or convertible)
Private Funds
REITs typically maintain standard bank operating lines to support
operating and related cash flow needs (paid down with public debt
issuances)
23
Financing - Canada
Declaration of Trust generally includes loan to value limits
REIT credit ratings are generally not sufficient to support
unsecured debentures
REITs not permitted to finance by way of preferred equity
REITs typically maintain standard bank operating lines
Long-term debt needs - convertible debentures
Recent amendments to the Canada/US Tax Treaty will reduce the
cost of capital further with the elimination of withholding tax
24
Financing - Australia
Typical REIT funding sources – choice varies with market
conditions
Further equity (e.g. rights issue or placement)
Wholesale fund spin-off
Bank and other debt
Convertibles/hybrid securities
Hybrid securities popular for REITs
Usually an attached funding vehicle
Driven by lower cost of capital and ability to tap different investor
base
Usually listed either on ASX or more recently Singapore
Often convertible/exchangeable into REIT equity
Often equity for accounting and bank covenants but with debt-like
features
25
Financing – Leverage limits
Jurisdictions
Leverage limits
Hong Kong
45%
Singapore
35% (60% if rated)
Australia
Unrestricted
US
None
Canada
60% generally
26
Financial engineering
Panellist: Yap Chee Meng
When does financial engineering cross the line and make
investors and regulators uncomfortable?
27
Financial engineering
Market conditions may encourage use of financial engineering,
e.g. to boost distribution yields
A variety of methods used in different jurisdictions, many
essentially involving return of capital to investors as part of
distributions
Examples:
Step-up interest rate swaps, fees and interest rates on borrowings
Hedging/borrowing arbitrage for cross-border REITs
Management fee waivers, or fees paid in units
Income support in relation to properties
Deferred payment for acquisition
Borrowing to pay distributions (distribution in excess of cashflow
from operations)
28
Financial engineering
Generally, regulators will allow a level of engineering with clear
disclosure. Similarly, investors will accept some, but overengineering has led to capital strikes (e.g. Hong Kong step-up
swaps)
29
Accounting
Panellist: Yap Chee Meng
What are the common accounting issues experienced by a REIT?
E.g. investment property classification/cash trap, deferred tax,
marking to market financial instruments etc.
30
Accounting
Cash trap arising from differences in accounting standards on
cross-border REITs
Deferred taxation on revaluation of investment property
Income support – revenue or adjustment to purchase price?
Acquisition of property holding company - acquisition of asset or
acquisition of business?
Revenue recognition – straight-lining of step-up rental income,
lease incentives e.g. rent-free
Consolidation - should a REIT Manager consolidate the REIT?
31
Governance framework
Panellist: Blair Cowper-Smith
Do REITs really provide an enhanced governance framework?
What are the pros and cons of the trust/trustee vs company
models, external vs internal management models?
32
Governance framework - General
Governance framework for REITs quite different than for
corporations
REITs may lack statutory protections:
Dissent rights in re-organization transactions may be lacking
Oppression remedy may be absent
Unitholder proposals may not be possible
Derivative actions not necessarily available
Creditor rights
Two tier structure a challenge in relation to governance
33
Governance framework - General
UPREIT Structure
100%
Public
REIT
Limited
Partners
Operating
Partnership
Assets
34
Governance framework - General
Fiduciary duties for trustees may be somewhat different than as
prescribed by corporate law
Risk of unitholder trust liability has resulted in the introduction of
protective unitholder legislation
Many REITs are managed externally - spin-off history
Separating management from the REIT permits isolation of
management related costs and limits the possibility of unwarranted
internal overhead growth but valuation discounts may apply
35
Governance framework – United States
US REITs – Maryland statute
Many US REITs organized in Maryland
Corporate or Trust REITs
Corporations have well-defined statute and that may not be altered in
certain cases:
Standard of conduct for directors; standards for dividends;
stockholder approval for charter amendments; procedures for
voluntary dissolution; appraisal rights; record dates
Trust REITs have more general statute and offer greater flexibility
Must be dealt with in the declaration of trust or bylaws
Shareholders appraisal rights in mergers may not be modified
36
International Bar Association Conference
Real Estate Investment Trusts
Panel 3 - REIT Operations
17 October 2007
Singapore