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Listed property sector, why change to REIT structure?

Posted On Wednesday, 20 March 2013 13:53 Published by eProp@News
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South African listed property sector has undergone some dramatic changes over the past 13 years, becoming increasingly sophisticated.

In 2000, the total market capitalisation of the property sector was about R5bn with little interest in it from institutional investors.

Today the market capitalisation of local listed property companies is more than R200bn. An important driver of the increasing size and popularity of the listed property sector has been its stellar performance since the early 2000s with an average compound return of about 26% a year.

With this strong performance has come more listings and interest from foreign investors who have begun investing in the larger property stocks.

One potentially problematic issue for South African listed property funds has been their historical structures. Most international investors are not familiar with the property unit trust and property loan stock structures. Furthermore, the property loan stock structure creates tax ambiguities.

In this context the introduction of the real estate investment trust (Reit) structure in South Africa from April 1 is arguably the most important event taking place in the listed property industry this year. The structure, which is common in much of the first world, will replace the property unit trust and property loan stock structures.

Why do property experts believe a change to a Reit regime is necessary?

Andrew Brooking, a director at Java Capital, explains the property unit trust structure is "quite an old structure" based on the common law trust concept where the property unit trust is a conduit for all of the rental income from the underlying properties of the fund. While property unit trusts are closely regulated by the Financial Services Board (FSB), they are considered "old-fashioned structures" not consistent with the active management model and investor accountability of a company.

Under a property unit trust structure investors cannot unseat the management whereas in a company the shareholders can remove the board.

"As an investor in a property unit trust your main recourse is a complaint to the FSB. The direct investor accountability is not part of the property unit trust framework," says Brooking.

While property loan stock companies may have a more active management model and offer greater investor accountability, there is a huge amount of tax ambiguity surrounding its structure.

The South African Revenue Service (SARS) has questioned the way property loan stock companies make distributions to their unit holders. Property loan stock companies distribute profits by clearing them as interest on the debenture part of a linked unit. Profits have grown and the interest rate of the debentures are at a level that may be unacceptable to SARS.

Brooking says SARS believes the payout on the debenture to unitholders is more like a dividend than an interest payment, especially if is higher than a commercial interest rate, and the tax treatment should be the same as if it was a dividend.

As it stands the market pricing of property loan stocks have not priced in any of this tax risk, says Brooking.

The new Reit regime is a tax dispensation for qualifying property vehicles in that if a property fund qualifies as a Reit then its qualifying dividends are tax deductible, says Brooking.

To qualify as a Reit, a property vehicle has to be listed on the JSE in the Reit sub-sector and 75% of its revenue must be derived from rentals, either directly or indirectly through an investment in another listed property vehicle or an unlisted subsidiary.

"As a Reit you have to pay out at least 75% of your distributable earnings and you can’t gear above 60% of the your loan to value," he says.

Adds Brooking: "One of the greatest advantages of the Reit system is that there is no more tax uncertainty of the flow through of net income. The investor is now responsible for tax on distributions received rather than the vehicle paying normal income tax."

Leon Allison, an analyst at Macquarie First South Securities, wrote in a September 2012 research report that following the adoption of the Reit regime, South Africa would become the eighth-largest Reit market globally, adding that the new Reit structure was "likely to be positive at the margin".

He also said there will be no conversion fee for property funds looking to convert to a Reit and that deferred tax related to property revaluations will largely be eliminated from balance sheets, boosting the net asset values of listed property funds. However, Allison also noted that a negative for foreign investors will be the introduction of a foreign withholding tax of 15% from January 1 2014.

Redefine Properties CEO Marc Wainer says the introduction of a Reit structure is positive for the listed property sector simply because of the clarity it gives to the treatment of tax. He believes the most important advantage of the Reit structure is that former property loan stock companies will not pay capital gains tax on the disposal of properties like they did previously. "That of course is also to the benefit of unitholders because they will get the full proceeds of any sale reinvested in the company."

Growthpoint Properties CEO Norbert Sasse says while he does believe there will greater interest in the South African listed property sector from foreigners following the adoption of the Reit structure, this will be limited to the larger listed property companies with market capitalisations of more than R10bn. This is because these property funds are more liquid and offer international investors the opportunity to "get into a stock quickly and get out very quickly".

Sasse says the interest in the larger listed property stocks will not just be from traditional listed property investors but also from asset managers who have "specific mandates to invest in Reits only". These asset managers have previously not been allowed to invest in property unit trusts and property loan stocks because their mandates strictly specify they invest in a property fund with a Reit structure.

Keillen Ndlovu, head of listed property funds at Stanlib, says that most of the large South African property counters such as Growthpoint Properties and Redefine Properties already have foreign shareholdings of between 10%15% but this can be expected to increase.

"This will increase demand for our listed property shares, which is a positive," says Ndlovu.

Frank Berkeley, managing executive of Nedbank Corporate Property Finance, says that South African listed property funds are "attractive and give very good returns". The adoption of a Reit regime would enhance these offerings.

Vukile Property Fund CEO Laurence Rapp says he believes there will be a gradual inflow of foreign investment into the larger listed property stocks following the adoption of Reits.

Rapp, who also chairs the marketing committee of the Property Loan Stock Association which is due to change its name to the South African Reit Association as of April 1, says this gradual inflow has the potential to "entrench a two-tier structure" within the sector with those funds able to attract foreign investment trading at a premium to the smaller illiquid funds which will not benefit from foreign inflows.

Source: BD 

Last modified on Wednesday, 20 March 2013 14:04

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