Melville Rodrigues, leading proponent of a new UK vehicle for real estate investors, urges the industry to respond to a Treasury call for input and to back the proposal
The UK has an unfortunate gap in its fund offering, compared with many other jurisdictions. It does not have – but needs – a closed-ended or hybrid solution for pension funds and other institutional investors to hold UK real estate investments – a fund that is unlisted, tax transparent and offers tradable units.
Fund managers are currently limited to alternative fund choices, which have drawbacks:
• Open-ended authorised fund structures, which must comply with regulatory operational requirements that erode returns and may be inappropriate for holding illiquid assets.
• Offshore alternatives, which face the challenges of – and incurring costs associated with – multiple legal, tax and regulatory regimes, including the maintaining of sufficient substance offshore.
The Treasury – via a call for input consultation (CFI) – is now offering a window of opportunity to rectify the gap, which could significantly improve the real estate funds sector through the introduction of a professional investor fund (PIF) – specifically the Association of Real Estate Funds’ proposal for a contractual-scheme PIF.
The UK Funds Regime Working Group and industry representative bodies such as the Alternative Investment Management Association, European real estate fund association INREV and the Investment Property Forum support the PIF. Many fund managers, institutional investors and other industry participants have already expressed their support for the proposal, even before publication of the call for input consultation. Many proponents of the PIF have indicated that they intend to file responses to the consultation supporting the PIF proposal before the 20 April 2021 submission date.
The PIF has a government/industry win-win attraction. As a conduit for institutional productive capital, the PIF can facilitate the government’s goals for COVID-19 reconstruction, infrastructure revolution and ‘levelling up’ the nation – that is, by supporting jobs outside of London. Real estate and its funds sector have much to contribute, for example, by attracting capital and reinvigorating town centres, supporting social and affordable housing and developing social infrastructure. Other sectors could also utilise the PIF, given it is designed to be unconstrained in terms of eligible asset classes and investment strategies.
Regulatory and tax considerations
The PIF is modelled on the existing authorised contractual scheme (ACS) legislation but is not open-ended, and for regulatory purposes would protect investors as a UK alternative investment fund and benefit from the flexibilities of an unregulated collective investment scheme.
It is envisaged that the PIF would be formalised as a deed (PIF deed), initially made between the PIF’s alternative investment fund manager (AIFM) and depositary. On admission, investors in the PIF would become parties to the PIF deed. The AIFM would make decisions on behalf of the PIF investors about the acquisition, management and disposal of the assets as well as risk management, subject to provisions within the PIF deed, and those decisions would be binding on the PIF investors.
Other features include:
- Investor status – restricted to professional institutional investors that. commit at least £1m, while other investors can only gain access through feeder funds that satisfy the professional institutional investor status.
- Registration – established and registered at a registry similar to that which applies in the case of an English limited partnership, a speed-to-market solution with no need for prior application to, or approval from, the Financial Conduct Authority (FCA).
The PIF would also have the advantage of operating with protected-cell sub-funds, providing a legally enforceable segregation of the assets and liabilities of each sub-fund. PIF managers would be able to operate a broad range of funds more efficiently: the sub-funds (or cells) are separately managed, charged, accounted for and assessed for tax, but do not have a separate legal personality.
The PIF adopts the co-ownership ACS framework: effectively tax transparent with tax liability applying to the investors as follows:
- Income and capital gains – income will be taxed on the share attributable to each investor, and capital gains will be taxed on each investor disposing its PIF units (but not on gains realised at the PIF portfolio level).
- Stamp duty – stamp duty is also modelled on the ACS. For example, in the case of PIFs holding UK real estate, it is proposed: no transaction tax, including stamp duty land tax (SDLT), will apply on the transfer of units in a PIF; and, as is the case with the co-ownership ACS and property authorised investment funds (PAIFs), SDLT seeding relief applies to the PIF. This will assist in launching new PIF projects with a similar clawback mechanism as applies for co-ownership ACSs and PAIFs to limit the scope for tax avoidance.
Responding to the CFI in support of the PIF
The CFI contains several other proposals worthy of consideration – for example, relating to real estate investment trusts and the long-term asset fund. In light of responses, the government will prioritise their top three proposals, and then progress with legislative change for those proposals.
To be enacted swiftly, the PIF would need to be within the top three government priorities following the consultation. If that were to happen, the PIF legislative could be implemented this year via secondary legislation that amends the Regulatory Activities Order and FCA consultation. There is no need for primary legislation.
We have a unique opportunity to address the current gap in the UK’s fund offering and improve the prospects for future generations of real estate fund managers. Supporters of the proposal are strongly encouraged to respond to the CFI, endorsing the PIF, by the 20 April reply date.
Melville Rodrigues is a senior fund consultant at Ocorian