Established six years ago, the UK REIT sector is still emerging. Specialist players, including housing REITs, could shape its development, writes Liz Peace
Government figures revealed that the UK thankfully avoided the dreaded triple-dip recession, albeit with a meagre 0.3% Q1 GDP growth figure. On the face of it, this represented small cause for celebration amid the unremitting gloom that has clung to the economy in recent times.
But a closer look at the Office of National Statistics (ONS) data reveals that if it were not for the struggling construction industry this figure would have been closer to 0.5%.
And while media headlines have inevitably focused on attempts to spur the house building industry in recent times, the government has also been working hard to kick-start investment in bricks and mortar by modifying the real estate investment trust (REIT) regime to “support expansion of the property sector and so encourage further investment and stimulate the construction industry”.
Recent entrants take the number of UK REITs to 26, which have a market valuation approaching £25bn (€29.3bn), although this underestimates the true size of the sector as a number of UK REITs are listed on exchanges for which market capitalisation figures are unavailable. Introduced in 2007, they allow investors to enjoy the same tax treatment as direct property ownership, while benefiting from diversification and professional management and avoiding the significant upfront cost and risks and responsibilities of day-to-day ownership.
Gone is the 2% entry charge that companies used to pay for joining the regime. Charged on the gross market value of their investment properties, it acted as a significant barrier to entry and disincentive to conversion.
REITs can now be listed on a wider range of stock exchanges than before, including the Alternative Investment Market and Plus. Previously, the official list of the London Stock Exchange was the only UK option.
Other important changes were designed to widen the REIT investor pool by relaxing the diverse ownership rule so that institutional investors could use the REIT vehicle for joint venture purposes. Previously, REITs had to satisfy a variant of the complex ‘non-close company’ test in tax legislation, which required it to not be controlled by five or fewer persons. Additionally, REITs now have a grace period of three years in which to meet this requirement.
And in the Finance Act 2013 the government will legislate to allow a UK REIT to treat income from another UK REIT as income of its tax-exempt property rental business, as well as further considering the case for REITs being included within the definition of ‘institutional investor’.
These changes taken together have helped to make REITs more attractive and, to some extent, have played a part in recent REIT conversions, including the Ground Rents Income Fund, Safestore Holdings and Assura Properties.
Despite these welcome additions, the market is still largely dominated by the traditional cohort of companies that led the market pre-REITs and transformed in 2007 to benefit from the tax breaks on offer. But what are the prospects for further development in the UK REIT regime? It is perhaps useful to look internationally at more mature and developed REIT markets for an indication of what the UK might expect.
A quick glance at the US reveals much greater diversity and specialisation with recent conversions, including cell tower, prisons and timber REITs, and mooted conversions in the next three years encompassing document storage, billboards and even casinos.
The UK market is still overwhelmingly focused on more traditional and familiar office, industrial and retail asset classes. It is likely to be some time before we see something as exotic as a casino REIT in the UK, but there are signs of the specialisation seen on the other side of the pond slowly emerging. GCP Student Living recently announced it will become the UK’s first student housing REIT, and Safestore Holdings, the largest self-storage operator in the UK, converted to REIT status at the start of the year.
There will probably be more specialist REITs than general portfolio companies, both as new specialists trickle into the market and larger companies specialise in high-performing sectors, such as the central London office market. Indeed, a consortium of international investors recently used the REIT structure to purchase Ropemaker Place from British Land for £472m.
What is clear, both from discussions with government and by looking at the scope of recent consultations, is that by lowering the barriers to entry to REITs across the board, it was hoping to see residential REITs established to play their part in tackling the housing crisis.
And based on overseas experience, the opportunity for residential REITs in the UK is substantial. With a post-Montague Review head of steam building up behind the private-rented sector, the opportunities to build or purchase residential portfolios of scale and with security of income are beginning to emerge. Genesis Housing, Grainger and former mainstay of rented housing Prudential, have all dipped their toe in the water and there is the hope that residential REITs will not be too far behind.
With the UK’s familiarity with residential as an investment class, whether buy-to-let or home ownership, there is significant untapped liquidity to be exploited by the UK REITs, perhaps on a scale commercial property has not achieved.
Development in the UK REIT regime is likely to represent evolution rather than revolution as they develop slowly over time – we should not expect a prison, casino or billboard REIT in the UK soon.
Liz Peace is chief executive of the British Property Federation