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Nicola Fritsch*, John Prebble** and Rebecca Prebble***
A Comparison of Selected Features of Real Estate Investment Trust Regimes in the United States, the United Kingdom and Germany
This is the last in a series of four articles, in which the authors compare specific aspects of the real estate investment trust (REIT) regimes in the United States, the United Kingdom and Germany. Previous articles dealt separately with the REIT regimes in each of these countries. 1. Introduction The United Kingdom1 and Germany2 have recently enacted legislative regimes setting up entities known as real estate investment trusts (REITs), with the intention of encouraging indirect investment in real estate in those countries. The United States3 has had a REIT regime since the 1960s and was, in many respects, a model for the UK and German regimes. However, both of the new regimes diverged from the US example and, indeed, from each other, in a number of ways. It is often difficult to guess at the reasons why national legislators choose one particular option over another, but this article considers the differences in national circumstances that might have led to the three countries enacting (or, in the case of the United States, continuing to use) different REIT models. The article also evaluates the advantages and disadvantages of certain features of each regime, and speculates about the future of REITs. Many jurisdictions have regimes that they call “REIT regimes”, but this uniform designation perhaps obscures the many differences between national regimes. “REIT” is not a legal term of art in the same way that, for example, “company” is. Company law differs from country to country, but the essential elements of companies are the same across jurisdictions. Companies all have legal personality separate from their shareholders and act through their directors. Their permitted activities are limited by their articles of association and relevant statutes. No such general statements can be made about REITs: REITs take many legal forms and, in spite of their name, are not necessarily trusts. To be considered a REIT, a vehicle must invest primarily in real estate and be granted tax advantages for doing so, but, broadly speaking, all other characteristics of REIT regimes are up to the discretion of the country concerned. Most national legislatures try to design REITs so that they mirror the tax effects of investing in real estate directly, but the mechanisms used to achieve this aim vary considerably. 2. Comparison of Features of US, UK and German REITs 2.1. The stock listing requirement There are a number of requirements that feature in many, but by no means all, REIT regimes. The requirement that REITs be listed is an example: when the United Kingdom and Germany enacted REIT regimes in 2007, the legislators in both countries decided that REITs should be listed on a stock exchange. This approach contrasts to the approach taken in the United States, where there is no such requirement, and the decision consequently faced considerable criticism from within the two countries. In the United States, unlisted REITs are an established part of the real estate investment market. The National Association of Real Estate Investment Trusts (NAREIT) estimates that one third of US-REITs are private.4 Similarly in Australia, with the world’s secondlargest REIT market, as well as Japan, with its still young but very successful REIT structure, both public and private REITs are permitted and operate successfully. Beyond the fact that a listing requirement is in itself comparatively restrictive, the specific characteristics of the listing requirements adopted by the United Kingdom and Germany appear to be unusually strict. UK-REITs must be listed on a “recognized stock exchange” – a definition that excludes the United Kingdom’s Alternative Investment Market (AIM). The AIM is a sub-market of
Dipl. jur., University of Augsburg, LLM Victoria University of Wellington, and Rechtsanwältin (attorney at law). The author can be contacted at firstname.lastname@example.org. ** BA, LLB (Hons) Auckland, BCL Oxon, JSD Cornell, Inner Temple, Barrister, Professor and former Dean of Law, Victoria University of Wellington, and Senior Fellow, Taxation Law and Policy Research Institute, Monash University, Melbourne. The author can be contacted at John.Prebble@vuw.ac.nz. *** BA (Hons), LLB (Hons) Victoria University of Wellington, LLM Columbia, and Analyst, New Zealand Treasury. The author can be contacted at email@example.com. 1. Nicola Fritsch, John Prebble and Rebecca Prebble, “Real Estate Investment Trusts in the United Kingdom”, Bulletin for International Taxation 5 (2010), pp. 259-270. 2. Nicola Fritsch, John Prebble and Rebecca Prebble, “Real Estate Investment Trusts in Germany”, Bulletin for International Taxation 6 (2010), pp. 320329. 3. Nicola Fritsch, John Prebble and Rebecca Prebble, “Real Estate Investment Trust Regimes Viewed Through the Lens of the US Paradigm”, Bulletin for International Taxation 4 (2010), pp. 211-223. 4. NAREIT, available at www.reit.com. The authors follow the industry convention of distinguishing national REITs in different countries by the initials of the country they are in. Accordingly, a REIT from Germany is a GREIT, one from the United Kingdom, a UK-REIT, and one from the United States, a US-REIT.
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8. 8. p. Prebble and Prebble. unlike companies listing on the main London Stock Exchange. institutional investors appear to favour public REITs due to the higher level of transparency. since the open real estate fund fulfilled this function.-4. Freshfields Bruckhaus Deringer. it is perhaps more flexible than the UK regime. the legislators reasoned that the German market did not need a new unlisted vehicle held only by a small number of (institutional) investors. 8 and trusts. unlisted open-ended investment companies). 7. Para.21 The phenomenon suggests that the objective of making REITs 5. in turn. Para. 19. Briefings in Real Estate Finance. The ability to list on the AIM would facilitate entities’ conversion to REITs and.14 One of the justifications for a mandatory listing requirement is the greater initial as well as ongoing disclosure requirements and market scrutiny that public companies face under capital markets law. “The Major Issues Facing the Successful Introduction of the UK REIT”.16 Investor protection was a particular priority for the UK and German governments due to recent scandals in real estate investment markets. pp. In the United Kingdom. available at www. 10. German Bundestag Commentary on the G-REIT Bill BT Drs 16/4026 8. it seems reasonable to interpret the rule in a way that the entity is required only to affirm that it reasonably believes that it will meet the condition when actually joining the regime. once they are established. Jack H. 3.com). “Promoting More Flexible Investment in Property: A Consultation” (March 2003. “A Primer on Real Estate Trusts: The Legal Basis of REITs”.. partnerships and private property companies could transition easily into the publicly listed REIT sector. 18. therefore. at least in the case of Germany. A previous article by the authors describes the vehicles that were available for real estate investment in Germany prior to the introduction of the REIT. Para. 4. The lack of a requirement that US-REITs be listed is partially credited with the success of the US REIT industry in the 1990s. Savills L & P Limited. HM Treasury and Inland Revenue.13 This requirement would be difficult for newly established companies to comply with. G-REITs are not supervised by the German financial supervisory authority (Bundesanstalt für Finanzdienstleistungsaufsicht). 12. 9. 11. 106(1) and 109(1) Finance Act 2006. Furthermore.18 The UK legislators. they do not have to provide a financial track record or trading history.12 Considering the effort typically involved in obtaining stock listing. Id 6. Secs. because.0. An earlier article of the authors described the various REIT structures that began to appear in the US market in the late 1980s and early 1990s. this allowance seems reasonable. 17. In the United States. 15.9. 5. p. 15.Articles the London Stock Exchange and was designed with the objective of giving smaller companies the opportunity to float their shares under a less restrictive regulatory system than the main market. 2. Petersen. took similar concerns into consideration. HM Treasury and Inland Revenue.7 Currently. Id. supra note 3. 2.11 Whilst the German REIT regime also requires that REITs be listed. Freshfields Bruckhaus Deringer. 8. Id. Although this preference for public REITs could be due to other factors.1. p. p.19 Another possible benefit of listing on a stock exchange is that it can help to ensure that small investors – one of the major target groups of the new vehicle – get the widest access possible. property companies that wish to convert to REITs and are already listed on the AIM must seek stock listing with a “recognized” stock exchange. Id.10 An AIM listing could be an option for investors holding few property assets to transfer property to a REIT. p. approved investment trust companies) have tended to attract less interest from retail investors than their unlisted counterparts. 1. available at www. 16. 2 Transactions: The Tennessee Journal of Business Law (2001/02). 13. German Bundestag Commentary on the G-REIT Bill BT Drs 16/4026. p. For example.10.10. See Fritsch. supra note 15. who wished to introduce a vehicle distinct from already existing forms of indirect real estate investment (in particular. Accordingly. supra note 2. 20. “REITs and Residential Investment”. The compliance obligations involved with seeking a second listing might well discourage otherwise eligible companies from becoming REITs. Prebble and Prebble. listed vehicles offering investments in asset portfolios by pooling money (in particular. Vol.12. such as greater fungibility of units. See Fritsch. In contrast.17 so there is perhaps some justification for reliance on listing as a governance tool. Listed vehicles also tend to provide a higher level of liquidity than unlisted structures. 15. as well as for small REIT start-ups to obtain a full listing at a later stage. in that an entity wishing to become a G-REIT can gain “Pre-REIT” status and enjoy tax privileges in relation to the transfer of properties to the entity prior to stock listing. No listing requirement meant that specialized REIT structures such as UpREITs could be created. See also Andrew Petersen. 9. No. 2. McCall. supra note 7. although investment trust companies have been present in the market for some time. 368 BULLETIN FOR INTERNATIONAL TAXATION JULY 2010 Investor protection is also likely to be an ongoing concern for Germany.org. as a compromise position instead of private REITs.uk). 2. supra note 6. provide a higher level of investor protection.hmtreasury. available at www. supra note 15.. in particular.freshfields. investor protection is likely to increase in importance. 14. UK law provides that the entity has to satisfy the listing requirement already at the time of notice to join the UK regime. 1 (2004). it is questionable whether a listed vehicle necessarily attracts more interest on the part of small investors than an unlisted structure. “UK-REITs: an Updated Guide to the New Regime” (December 2006.5 The UK property industry had been lobbying for an amendment that would allow REITs to be listed on the AIM. also hopefully encourage residential REITs6 because the pool of potential companies that can convert to REIT status is currently very small and would most likely become larger with a more generous rule regarding stock listing.9 This development contributed to the US REIT market starting to boom in the early 1990s. Considering the crisis in global financial markets that directly followed the introduction of both regimes. 1. under the GREIT regime as it currently stands. 4. 2 G-REIT Act. Savills L & P Limited. Para.15 Increased disclosure and reporting requirements.20 However.gov. The stock exchange effectively takes the place of a government regulator as far as G-REITs are concerned. Sec. such as open-ended investment companies.reita. 8-9. 21. © IBFD .
avoid unfavourable price cycles on capital markets and then go public once they feel ready for the capital market. Collective offshore vehicles are. Petersen. in particular.. Para. the private REIT could provide certain investors with a choice and perhaps a more flexible alternative investment vehicle with advantages over the public REIT. Id.33 In the United States. 2. p. Para. 31. 32. Petersen. both in terms of market volume and the potential competitive market position that such a structure might have on the national as well as European stage.. not least due to the high costs involved and considering that initial public offering normally costs around EUR 300 million. German Bundestag Commentary on the G-REIT Bill BT Drs. 7. pp.org). disclosure. thereby combining the © IBFD advantages of a tax-transparent clear-cut investment vehicle with the simplicity of an unlisted vehicle. amounting to about 17%. the residential sector was among the top-three sectors within the North American region.. to ensure that only “sophisticated” investors have access to this investment option.und Wohnungsunternehmen e. On the international stage. p. 33.de).. 28.22 The listing requirement also means that existing limited partnerships or unit trusts are hindered from converting to REITs directly. 6.2. Id. 27. would be an asset class different from open real estate funds. HM Treasury and Inland Revenue. available at www. supra note 15. HM Treasury and Inland Revenue. The existing market in property building and developing is partly dominated by small and mediumsized companies. 35. Savills L & P Limited.1 million apartments – of the total rented housing is held by public and communal housing companies. a step that does not seem possible with only public REITs on the market. Id. one possible approach might be to implement a number of restrictions into the regime governing unlisted REITs.“Global REIT Report 2007” (October 2007. If entities are given the free choice whether and when to go public. 3. 9-10..12.30 Private REITs are certainly an option worth considering for the UK and German markets. unlisted REITs would need to be subject to the same regulatory.32 2.13. moreover.. 34.bund. In 2007. pp. p. BFW) presented a number of strong arguments in favour of unlisted REITs in a discussion document on the “Importance of non-stock exchange-traded REITs for the success of REITs in Germany” (“Bedeutung von nicht-börsengehandelten REITs für den Erfolg von REITs in Deutschland”). similar to the existing authorized unit trusts and open-ended investment companies.28 Private REITs.V. p. 36. 1.3. supra note 15. 30.. supra note 15. BfW.23 Although unlisted vehicles are not subject to the same level of publication and disclosure requirements as listed vehicles. Sotelo et al. “Bedeutung von nicht-börsengehandelten REITs für den Erfolg von REITs in Deutschland”. 29. some feared that the introduction of REITs might have unwelcome effects for tenants and interfere with public-sector social and sustainable hous- 22.25 The German Association of Independent Real Estate and Housing Companies (Bundesverband freier Immobilien. BULLETIN FOR INTERNATIONAL TAXATION JULY 2010 369 . position themselves on the market. 23. p. p. “Comparison of Approaches to Housing Policy in EU Countries”(November 2005. Of course. Ernst & Young. 9-10. there is room in the German market for a private REIT vehicle for indirect real estate investment alongside the existing ones and complementary to the listed REIT. p.29 Closed real estate funds. giving investors the free choice between a private and public REIT has been an important factor for market efficiency and performance. could be transferred into private REITs. 2.26 According to the BFW. Ramon Sotelo et al. Bundesamt für Bauwesen und Raumordnung. Id.reits-indeutschland.36 Because of these statistics. the German legislators decided not to allow G-REITs to invest in residential property built before 2007 (2007 being when the German REIT regime was enacted). unit prices are regularly published and investors are provided with a reasonable level of liquidity through the obligation to redeem units. Germany has a relatively large percentage of people living in private and communal rental housing compared to elsewhere in Europe.reita. supra note 7.24 In order to achieve sufficient protection for investors. a product that small investors are already familiar with. Id. and publication requirements as public REITs if they hope to attract the same calibre of investors. 16/4026.34 In spite of the success of US-REITs in residential property markets. 18.bbr. they can more thoroughly prepare their real estate portfolios. supra note 26.35 Around 15% – 3. REITs and investments in residential property The US REIT regime contains no restrictions on REITs investing in residential property and consequently investments in residential properties are an established part of the US REIT market. This would be an important step towards more transparency and professional management and fungibility for this sector. Especially for smaller companies. Paras. 71. unlikely to consider converting to a REIT to be an attractive option. the option of a private REIT might open up new opportunities. 25.de. for example. 6. as allowing for better maintenance and renewal of properties as well as for more efficient property management. available at www.. it can be particularly difficult to gain access to stock markets. REIT institutional investors have been entering the residential market in increasing numbers. 2. 26. supra note 15. which are currently the most important investment vehicles for real estate investment on the German market.1. available at www. 24.27 In this respect.Articles available to small investors could also have been achieved through an unlisted structure. This development is generally considered to be positive. which are well established and. with their regional and property-type-related specializations. Alongside the public REIT.31 Private REITs could moreover serve as important vehicles for entities in the stage prior to going public as well as pose an alternative to popular offshore structures.12 and 2.
47 Similarly. Savills L & P Limited. Different REIT structures are also expected to emerge due to this. based on the assumption that REITs’ main concern would be to maximize profits. for example. 1. tenants are well protected under German landlord and tenant law. Sotelo et al.45 Large stocks of apartments held by communal bodies have been suffering from a lack of maintenance and little effective management.43.11. there initially might be few potential properties suitable for institutional REIT investments on the market in the short term. available at www. some even suggested introducing an obligatory requirement that REITs hold a certain percentage of their assets as residential property. Para. 40 Even so. The United Kingdom saw REITs as having potential to help “address the problem of the provision of affordable housing including for key workers in areas of high house prices”. Id. Id. even facilitating access for small companies to the REIT market. “Deutsche Wohnungen im Focus internationaler Investoren – Dritte Welle von Investoren drängt auf den Markt”. Id. 48.44. Neue Zeitschrift für Miet.. Id. 44. these concerns do not appear to be fully justified. p.uk). These apartments could be sold to REITs. 41. Guido Eusani.37 One particular worry was that rents might rise.51 the sale of property to a REIT might even be the more socially advantageous alternative.49 Sec. Id. The BGB provides sufficient protection for tenants and there seem to be no rational reasons for excluding residential property as an investment target. Id. Special Edition G-REITs (Wolfratshausen: Going Public Media AG. 49. experiences with private equity investments in residential property and residential REITs in 370 BULLETIN FOR INTERNATIONAL TAXATION JULY 2010 other countries have tended to show positive effects for tenants through professional management.50 but only if there have been no prior rent increases within the last 15 months and the rent increase does not exceed 20% within the last three years. supra note 7. 72.11 and 2. with institutional investors entering the market. supra note 15. thereby not only providing länder and communities with extra funds. considering that REITs’ investments tend to be longer term than those of private equity funds. HM Treasury and Inland Revenue. “Mietwohnungsmarkt und Wohneigentum: Zwei Seiten einer Medaille” (November 2006. Oliver Puhl. fears of rising rents due to luxury renovations or profit-maximizing business strategies do not seem to be justified. “Review of Housing Supply: Securing our Future Housing Needs (Interim Report to the United Kingdom Government)” (2003. During the development of the UK REIT regime. through cost-intensive demolitions of inefficient and rundown buildings. Compared to the sale of residential properties to private equity funds. lease terminations and the resale of the property or luxury renovations for a certain period of time. In practice.mieterbund.43 Considering that no other county seems to have imposed restrictions on investments in residential property. © IBFD . and Deutscher Mieterbund. Kate Baker. available at www. 39 whereas the German government feared that REITs might cause a steady increase in rents and a decline in affordable housing. p. supra note 15. 559 of the German Civil Code (Bürgerliches Gesetzbuch. in the best possible scenario. however. “Wohnungspolitk muss Mieterinteressen Berücksichtigen” (November 2006. 42 Unlike the German experience. 558 BGB. leading to a significant expansion in the “buy-to-let” market.48 But even without these kinds of safeguarding contractual agreements.gov. “Regierungsentwurf zum Real Estate Investment TrustGesetz (REIT-Gesetz) – nur eine kleine Lösung”. institutional investors tend to be at least as cooperative and understanding as amateur landlords. it is questionable whether the concerns of German legislators are justified. there is no evidence of a conflict between a REIT’s policy objectives and Germany’s socio-economic objectives.46 Contrary to the concerns of interest groups and the German legislators. even if they wanted to. 1.und Wohnungsgrecht (2007)..de).41 Consequently. which is one of the world’s most comprehensive and favourable as far as tenants’ rights are concerned. since German residential tenancy laws are sufficiently strong that residential G-REITs are unlikely to be able to raise rents much. and more efficient cost structures and maintenance. p. In the longer term. 51. 2. 43. Paras. 73. only costs of modernizations increasing the “utility value of the leased property” – a term that excludes the costs of luxury modernizations – can be passed on to tenants. 46. specialized residential REITs are expected to develop newly purpose-built rental flats in locations of high demand. Michael Voigtländer. p.hypverband. Para. 88. supra note 26. 42. there are no restrictions under German law preventing foreign REITs from investing in German residential property. over 70% of privately rented housing remains in the hands of landlords who manage only a small number of properties. smaller companies merging or. Barring only German REITs from residential property invest- 37.13. but also avoiding further expenses caused. 30% of which comprises the private rented and social housing sectors. 50. 2006). 72. Perhaps incongruously.38 However. 1.44 According to the discussion document produced by the BFW. 45. with a willingness to draft contracts to exclude rent increases. In the United Kingdom. HM Treasury and Inland Revenue.. BGB) limits rent increases in cases of modernization to 11% annually. 47.. available at www. Moreover. 39. Germany’s attitude towards the possibility of REITs investing in residential property contrasts with the United Kingdom’s. Sec.. 38. 2. Para. Both the UK and the German residential housing sectors differ from the North American one.hm-treasury. A landlord may increase the rent up to the level of the reference rent that is customary in the locality concerned. which is already common practice. the UK government at an early stage saw REIT investments as a means to increase investments by institutional investors in the residential sector. investments in the private rented and residential property sector have increased in recent years. p. which does not restrict REITs from investing in residential property.de). These aspects of the comprehensive tenancy law framework under the BGB suggest that tenants are not likely to become deprived of any rights if their property is taken over by a REIT. 40.Articles ing policies and urban development.
3.66 The issue is even more acute in the context of the current economic downturn. “The Finance Bill 2009” (Third report of session 2008-2009). pp. Special Edition G-REITs. some level of borrowing seems essential to be able to acquire new properties and to meet unforeseen liabilities without having to hold large cash reserves.reit. p. “Der Synthetische REIT – Mehr Als Nur Plan B?”. 3.1 and European Public Real Estate Association (EPRA). supra note 15.2. “Franzosen kaufen 40 000 Wohnungen”.com). gearing is an important and necessary capital source for any kind of company on the market. The gearing restrictions set out under the UK and German regulations lie significantly below the level of less risk-averse private equity funds.59 thereby transferring returns from income oriented to capital oriented. supra note 9. supra note 15.60 The intention was to create a structure different from that of an ordinary property company. a process that has already started – for example.1. Para.67 In practice. with some blaming the fact that yields from residential property in the United Kingdom have historically been low and such investments require considerable administrative effort. where REITs are finding themselves in straightened circumstances.3. Para. Eusani. the failure of UK-REITs to move into residential property investment is regarded by many as an indication of overall poor design of the United Kingdom’s REIT regime. see Volkert Volckens. McCall. 59.64 Gearing restrictions should also be considered in the context of the distribution requirements REITs in all regimes must comply with. 16/4026. 2. The United Kingdom has faced criticism from the property industry for its failure to relax the gearing ratio or take other measures to help REITs.68 Accordingly.63 Considering that real estate requires ongoing maintenance. 23. supra note 15. Para..61 as well as to ensure that REITs maintained sufficient financial power and stability.52 If Germany continues to restrict REITs’ access to the residential property market. 63.epra. p. the application of stamp duty land tax.com). Id. available at www. Wall Street Journal (5 September 2009.de). available at www. 56. Guidance GREIT 02200. supra note 46. 9-14. 54. 68.56 Opinions on why there is institutional reluctance to invest in residential property differ. Instead. in spite of the fact that 52. however. Para.58 Whatever the underlying reasons. servicing and refurbishment. 60.62 Although these concerns are reasonable in one sense. Consequently. p. supra note 15. consider that half of German property holdings are in residential real estate. 61.3. which is also due to their relatively moderate leverage levels. 261. For REITs. listed on the Paris stock exchange.2 and 2. it is hard to see how they will become competitive with international REITs. Gearing restrictions Although there are no gearing restrictions in the US REIT regime. German Bundestag Commentary on the G-REIT Bill BT Drs. 68. p.wsj. 263.3.25. 23 June 2009. 2. it might find that German companies begin to establish REITlike structures that formally do not have REIT status. imposing gearing restrictions might hinder the effective and dynamic management of REITs and their potential projects. that simply permitting REITs to invest in residential property does not ensure that they will do so. The German government might. Beiten Burkhardt Rechtsanwaltsgesellschaft mbH (November 2006.53 via holding structures on foreign markets. 5. 250. Petersen. p. BULLETIN FOR INTERNATIONAL TAXATION JULY 2010 © IBFD 371 . 40. The United Kingdom’s reasoning was that REITs should not be burdened with high debt servicing costs that would reduce profits and result in fewer potential distributions to investors. See Larry Light. leaving a considerable amount of dead capital that could be better used. 258. Para.3.54 to circumvent German restrictions. 2. The gearing ratios of a number of REITs have increased significantly over the last 18 months. It is worth remembering. 55. “The Investors Guide to Real Estate Investment Trusts (REITs)” (2009. 2. “EPRA Global REIT Survey” (August 2007. Para.000 apartments were taken over by a French REIT. 62. supra note 15.deutsche-boerse. Id.com. 71.. available at www. 65. The G-REIT’s leverage is limited to 55% of the value of its immovable property. in response to market pressures. Sibeth Partnerschaft. Germany should ensure that the G-REIT is internationally competitive to prevent more German real estate landing in the hands of foreign REITs. 66. “Der G-REIT aus Kapitalmarktsicht – Die Struktur entscheidet über den Erfolg”. in 2006. HM Treasury and Inland Revenue. Petersen. HM Treasury and Inland Revenue. 57 Others. The UK regime indirectly limits gearing by imposing a tax charge if the finance cover ratio falls below 1. 65 Raising money in this way can be costly and is not always in the interests of existing shareholders. NAREIT. On synthetic REITs in general. “Legislation – Optimistic Start for G-REITs?”. both the UK and German legislators chose to impose borrowing limits on REITs when designing their own regimes. but to date there are no residential REITs in the United Kingdom. The United Kingdom hoped that UK-REITs would invest in residential property.55 Unless German REITs are permitted to participate in the residential property market.com). however. available at www. which are typically 90% to 95% leveraged. therefore. Id. through increases in share capital and private or public stock offerings. United Kingdom House of Lords Select Committee on Economic Affairs. “The Finance Bill 2009” (Third report of session 2008-2009). the capital markets are their only viable source of finance. 58. 53. supra note 15. United Kingdom House of Lords Select Committee on Economic Affairs. Para. 2. See also Peter von Barkow. if REITs are restricted in their borrowing power. and HM Treasury and Inland Revenue. however. 9-14. available at www. 64. 67. HM Treasury and Inland Revenue. pp.Articles ments seems inconsistent with the aim of ensuring comprehensive protection of the residential tenancy market if foreign REITs can invest in communal and social housing freely. The rule that a REIT must distribute around 90% of its income to its shareholders leaves the vehicle with few net proceeds and little financial scope to manoeuvre.sibeth.3. in particular. Die Welt (6 October 2006). 23 June 2009. blame defects in the UK-REIT regime itself. Paras.3. “Cracks in the REIT Rally’s Foundation”. supra note 51. 57. the average debt ratio of REITs in the United States has generally been below 55% for much of the last decade and around 65% of REITs are rated investment grade.
probably depends on the specific circumstances of each market. p. might prevent offshore vehicles from returning. Sec. However. They are.4. in practice. supra note 15. however minimal. there is a 2% flat tax conversion charge on the market value of the property rental business assets.69 Given these international examples.com). © IBFD BULLETIN FOR INTERNATIONAL TAXATION JULY 2010 . Berwin Leighton Paisner & DTZ Group. EPRA. 75.78 The German entry charge. McCall. As far as investors are concerned. In the United States. 79. available at www. 4. EPRA. free to have a high leverage if needed to finance property acquisitions or other necessary investments. 70.76 The French charge is a 50% tax reduction on the capital gains tax normally payable on the transfer of assets.Articles there is no restriction on gearing under the US regime. nevertheless. Instead.74 No corresponding structures have been developed in Germany or the United Kingdom. Para. set a 16. Built-in gains are gains from the appreciation of property that must be recognized on conversion to a REIT. 73. supra note 55. 77. The introduction of the UpREIT structure. France. 27. With these concerns in mind.77 In the United Kingdom.blplaw. This privilege was limited until 1 January 2010 and is subject to further restrictions. However. Id. the United Kingdom and Germany have each taken distinct legislative positions regarding the tax consequences of transferring assets to REITs. 8. if it does not sell them or enter into any other kind of taxable transaction with those assets during that time. 2. on the other hand. for example. they can choose whether they wish to invest in a more or less risk and cost-adverse REIT. A 50% tax reduction for capital gains realized on conversion is certainly within the range of reasonableness. there are no borrowing restrictions imposed on the vehicle.e. 372 The US experience might lead to questioning whether the German and UK exit tax and entry charge were set at sufficiently low levels so as not to discourage potential investors from transferring property to REITs. p. HM Treasury and Inland Revenue. p. “Built-in gains” are subject to corporate income tax. p. Too onerous a charge discourages existing property vehicles from converting to REITs and investors from transferring property to a REIT. the three-year transition period granted by the German legislators in providing for a reduced exit tax seems short. p. there is a 50% tax reduction (exit tax) for the gain realized on the transfer. which will delay the full development of new REIT industries for some time. there is generally no tax-privileged treatment for the transfer of property to a REIT or the conversion into a REIT. HM Treasury and Inland Revenue. The US experience has shown that the taxes arising on conversion deterred companies from directly converting into REITs.5. Para.17 and Petersen. built-in gains realized on the transfer of property are tax-free. 11.5. 78. i. the conversion into a REIT or sale of properties to a REIT always constitutes a taxable event. practitioners had considered a tax amounting to around 10% of embedded capital gains reasonable. However.79 It remains to be seen how innovative practitioners will be in developing more advanced REIT structures that reduce the tax burden for investors. 72. available at www. 73 The tax treatment of built-in gains set free on the transfer of property to a REIT or conversion of an entity into a REIT is an important aspect of all REIT regimes. however. in many countries. practitioners developed advanced structures that allowed for a tax-free or tax-deferred transfer of property.72 Under the UK regulations. HM Treasury and Inland Revenue. led to a significant revival of the REIT market in the 1990s. 76. 3 Income Tax Law (Einkommensteuergesetz). The more built-in capital gains potential REITs have. Which out of the UK and German approaches is most effective. 74. the UK entry charge seems to have been set at a relatively low and reasonable level. permitted gearing levels for REIT structures vary significantly. Para. the more favourable the United Kingdom’s flat 2% entry charge on the property rental business assets seems. 2. Full taxation on conversion or transfer of property 69. it seems likely that the UK and German REIT markets could benefit from a less restrictive position on gearing. 71. US-REITs tend to have made moderate rather than excessive use of debt financing. industry bodies called for a total tax exemption on capital gains released on conversion to REIT status. Worldwide. “Promoting More Flexible Investment in Property (Joint Submission to HM Treasury & Inland Revenue)” (2004. The motivation for suggesting such a generous rule seems to have been a feeling that any tax charge. In Germany.5% exit charge on latent capital gains on properties transferred to REITs. 4. supra note 75 and Von Barkow. This projection seems particularly true in the light of recent events in the global real estate market. given that the REIT market will need several years to develop. which gave investors a way to avoid taxation on built-in gains.1. In any case. supra note 15. 250. supra note 15. supra note 60. by contrast. as is the case with the successful and established Australian and Japanese REITs. as long as they are aware of the REIT’s leveraging practices and debt servicing costs involved. could perhaps have been set lower.75 although the UK and German legislators are presumably well aware that too low a charge creates a way for entities to dispose of built-in gains without giving rise to taxable events.epra. Table 2. 77.70 An exemption may apply if the REIT concerned holds the assets in question for at least 10 years. Berwin Leighton Paisner & DTZ Group. supra note 9. but this is perhaps not surprising given the relatively recent introduction of these regimes and the global recession that immediately followed their introduction. They were anxious to ensure that their respective REIT regimes did not produce an overall loss in tax revenues for the state. but it is worth noting that during the consultation period in the United Kingdom. Exit tax and entry charges The United States. as are other kinds of capital gain. supra note 15. 71 Both the United Kingdom and Germany have chosen not to follow the approach of the US model.com). “EPRA Global REIT Survey” (December 2008.
5. At the same time. BULLETIN FOR INTERNATIONAL TAXATION JULY 2010 © IBFD 373 . irrespective of whether the income stems from real estate-related sources or not. In particular. but income in this respect excludes capital gains. supra note 83. Accordingly. 91. 81. 88. therefore. corresponds to the respective tax exemption granted under the regimes. The downside of this approach is that it encourages the entity to distribute more of its income than is legally required to take advantage of the tax privilege. They are not required to distribute any particular percentage of their income that does not enjoy tax privileges. REIT regimes aim to allow small investors the opportunity to invest in real estate in a similar way to large investors who are able to invest directly. The German REIT regime offers the most comprehensive tax exemption at the entity level.82 This difference in tax treatment means that UK-REITs have more freedom to engage in secondary activities related to real asset management than G-REITs. 93. rather. Gänsler. US-REITs are. 105(3)(c) and 119(2) Finance Act 2006. In return for doing so. Internal Revenue Code (IRC). p. Internationales Steuerrecht (2007). supra note 51. 64. p. Sec. therefore. The authors have described the mechanics of this tax treatment in more detail in Fritsch. totally and personally exempting G-REITs from corporate and trade income tax. the US. a key component of any regime must necessarily be a requirement that the indirect investment vehicle actually pays out its profits to its shareholders regularly. 87 2.89 The difference in the distribution requirements between G-REITs and UK-REITs are a necessary consequence of the different tax regulations.81 All other income. Para.5. Katrin Gänsler. 90 In practice. “Internationale Systeme der Besteuerung von REITs”.93 Another consequence is that REITs are highly dependent on rising funds from the capital markets and through borrowing (although borrowing is also restricted in Germany and the United Kingdom). supra note 15. considering that only UK-REIT income that stems from property rental business is tax exempt. 87. UK-REITs are not totally exempt from corporate and trade income tax simply by virtue of being REITs. however. but the manner in which they put this philosophy into practice differs. Legal form and minimum share capital In the United States. “Einbringung von Immobilien in REITs – Steuerrechtliche Anreize zur Mobilisierung von Immobilienbeständen”. Internationales Steuerrecht (2006). The distribution requirement. Sec. Taxation at the corporate level Under Germany’s REIT regime. The three regimes share an underlying philosophy. 13(1) G-REIT Act. supra note 15. dividends that are distributed to shareholders are deducted when calculating a REIT’s income. preferable to the UK one. they receive a tax exemption (this quid pro quo is most literally true of US-REITs. 82. however. HM Treasury and Inland Revenue. is fully taxable. 89. including income from a REIT’s interests in other REITs. REITs in the United Kingdom are required to distribute 90% of only their tax-exempt income from property rental business.88 In contrast. 83.86 Distinguishing between two types of REIT income unnecessarily complicates the already complex tax regimes for UK-REITs and their managers. Id. Para. must distribute 90% of their total net income. At the same time. UK and German REIT regulations require REITs in each country to distribute the lion’s share of their income to shareholders. 86. perhaps. 407. p. Similar to the German regime.91 Consequently. which was after all the United Kingdom’s aim in introducing a REIT regime. which may deduct distributions to shareholders from their taxable income). pp. 2. 92. US-REITs might feel tempted or even compelled to distribute a higher percentage. since only distributed income is exempt from taxation.6. Berwin Leighton Paisner & DTZ Group. Petersen. Andreas Knebel.14. “REITs in Deutschland und Großbritannien – ein Vergleich”. 857. whereas the G-REIT’s total income is subject to the tax privilege. supra note 1. it is difficult to assess which method of entity taxation is better overall as this question is closely tied with the policy objectives of the particular national regime. which are tax exempt regardless of the source of their income. which makes the tax exemption dependent on the type of activity the income stems from. German REITs. 90.85 All retained income and capital gains are subject to corporate income tax. only the profits that stem from their property rental business are taxfree. supra note 9. limited 80.84 In the United States.8. the relevant US rules require REITs to distribute 90% of their taxable income. The distribution requirement One of the core requirements of any REIT regime is that REITs must distribute most of their profits to shareholders.Articles to a REIT certainly deters potential investors if at least some postponement of the tax or relief is not granted under specific circumstances. Consequently. 85. a partnership.7. Secs. some US-REITs have only small amounts of net proceeds readily available for investments or other expenditures. 2. disinclined to hold cash reserves. corporation. The German approach is. which may become problematic if unforeseen circumstances arise. 8-12. IRC. Special Edition:G-REITs. p. McCall. a REIT can be of any kind of US entity (for example.80 2. 104. 4.9. 3. 84. supra note 75. Sec. all income and capital gains are exempt from corporate or trade income taxes. The distinction between tax-exempt and non-tax-exempt income for distribution purposes might have a positive effect on UK-REITs’ ability to hold cash reserves.83 The fact that non-property rental income is not tax privileged in any way might encourage UKREITs to engage primarily in property rental business. the income from those activities of a UK-REIT is fully taxable. there are differences as to the scope and type of income that has to be distributed.92 This result is a downside of the distribution requirement: REITs have only a small amount of retained earnings that can be invested in growing the businesses internally. Uwe Stoschek and Helge Dammann. Prebble and Prebble. In contrast. 857.
A REIT might. Inland Revenue.98 German lawmakers ultimately rejected the trust option. 98. but there are many potential borderline cases where it is not clear how this requirement will be interpreted in the long run. Sec.100 Open-ended vehicles investing in illiquid assets such as real estate might encounter difficulties if they can be required to redeem units on request. Eusani.15-2. Sec. require a higher minimum capitalization than a normal stock corporation. although the structure has not been particularly successful.108 This explanation is not fully satisfactory. 108.97 Even on the international stage.de). p. since real assets might be difficult to liquidate quickly or only under unfavourable market conditions at the time of the request. “Formen von REITs als indirekte Immobilienanlage”.107 Malls and hotels are clear cases on either side of the single-property line. a closed-ended structure would mean more diversification and flexibility for investors. Initiative Deutsche Wohnimmobilien – REITs. 27. HM Treasury. German law contains provisions for trusts. IRC. but they do not provide for a separation of the real assets from the actual stock corporation. such as authorized unit trusts and open-ended investment companies. Nevertheless. such as a hotel. but they do not necessarily need to be listed on the London Stock Exchange. i. 2. 95. so.Articles liability company or business trust).bundestag. The requirement to hold a minimum of three properties prevents highly specialized UK-REITs from investing in just a single property. However.99 Faced with these impediments. UK-REITs must be listed. Germany’s decision to use the AG structure for its REIT regime seems reasonable.000.102 which is another reason why they did not seem the ideal legal form for a REIT structure. available at www. probably because there is no tradition of trust structures being active in the German market. Any recognized stock exchange suffices. HM Treasury and Inland Revenue. Furthermore. existing openended structures for real estate investment have been unable to invest all of their assets in property. 107.8. p. it is possible for a UK-REIT to be subject to a different minimum share capital requirement. fitted and equipped for separate rental. considering that there are already open-ended structures on the market. 101. Sec. being units that are designed. a vehicle investors are already familiar with.105 respectively.94 The REIT regimes in the United Kingdom and Germany are more restrictive. rather than a requirement of being a UK-REIT per se. 846(a). due to the increased costs arising from the obligatory stock listing and related publication requirements. the increase in the normal minimum share capital requirement for stock corporations under the German regulations from EUR 50. 106.95 UK-REITs must be closed-ended companies that are tax resident in the United Kingdom. 96. supra note 51. 104. supra note 75. Sec.22.96 In Germany. The advantage of choosing an open-ended structure would have been that there are already well-established products on the market. 134 Finance Act 2006. It is difficult to guess at the motivation for the UK rule. © IBFD . EUR 15 million104 and GBP 50. Guidance GREIT 02030. 2. Paras. there was no existing legal framework in Germany that would support the kind of trust structure that a REIT would require. supra note 15. For example. The minimum share capital requirement is a requirement of listing on the London Stock Exchange. Para. depending on the exchange it lists on. “Schriftliche Stellungnahme zum Entwurf eines Gesetzes zur Schaffung Deutscher Immobilien-Aktiengesellschaften mit Börsennotierten Anteilen” (prepared for the German Bundestag (28 February 2007. AktG). indeed. but in the absence of any other rationale it is probably correct. Special Edition G-REITs. as long as it has elected to be treated as a domestic corporation for tax purposes. but one possible reason for its inclusion might have to been provide for a minimum diversification for investors. which are familiar to investors.101 As a result. A shopping mall. because surely smaller investors would also benefit from being able to invest in single-property REITs. AG) under the German Stock Corporation Act (Aktiengesetz. the UK legislators ultimately decided in favour of a closedended vehicle. one model that enjoyed a considerable measure of support was the trust model. both the German and the UK legislators introduced a minimum share capital requirement for their structures. Id. as a REIT regime relying on the structure would require. 99. See Berwin Leighton Paisner & DTZ Group. on the other hand. in theory. 103. would be an eligible property for REIT investments because the individual shops are considered to be separate properties. 100. 4 G-REIT Act. Hanspeter Gondring and Yvonne Weick. with one of the determining factors being that there are a number of dangers inherent in investors’ redemption rights in open-ended structures. 107 Finance Act 2006. supra note 46. the stock-listed AG is an established vehicle for indirect real estate investment in form of the “Immobilien-AG”. Para.e. requiring REITs to be established in a certain legal form. 97. the main question regarding legal form was whether to opt for an open-ended or a closed-ended vehicle. This legal form was not the only possible vehicle considered. Id. in view of the fact that one of the reasons for the regime’s enactment was to provide smaller investors with opportunities to invest in diverse property portfolios. since neither the German nor the US rules provide for a corresponding requirement. supra note 15. although their place of incorporation may be elsewhere. Furthermore. the AG is a recognized corporate structure.6. 94. which is similar in form to the structure provided for under US law. There is only one permitted legal form for G-REITs: that of the stock corporation (Aktiengesellschaft.106 The existence of this rule is perhaps surprising. and legislators were concerned that the unfamiliar structure would make investors wary of participating. In the United Kingdom. thereby further preventing smaller companies from entering the REIT market. 3 G-REIT Act.17. The scope of REITs’ business activities The UK REIT regime contains a rule requiring REITs to hold at least three separate assets.103 374 BULLETIN FOR INTERNATIONAL TAXATION JULY 2010 Although there is no minimum share capital requirement under the US REIT regime. however: during the development stage of the German REIT regime. 1. 66 for an explanation of the many drawbacks of Immobilien-AGs. 102. 2.000 to EUR 15 million is an enormous one. Sec. 105. which is a requirement to qualify for authorization as a collective investment scheme.
EPRA. The UK and German regimes are good examples in this respect: both countries impose restrictions on their REIT structures regarding property development activities. However. provide services to the REIT’s tenants. 114.116 In the United States. This limitation means that G-REITs may not generate “bad income” from non-real estate-related sources. 115. within the 25% 109. over a five-year period. McCall. permitting some measure of property development activity ensures the vehicles’ competitiveness. imposes the restriction that. Once a property is sold “by way of trade” or is “developed for sale”. 223. The taxable REIT subsidiary can then use the property to. through hotel management. was essential for the two European REIT structures. however. rather than from selling them. also bearing in mind that in competing collective investment vehicles in the UK market. US-REITs may conduct real estate development for third parties via taxable REIT subsidiaries. Sec. Guidance GREIT 02075. One kind of property that is often managed in this way is a hotel building. G-REITs may dispose of property generating profits of only up to 50% of the average market value of its property over that same period. security services. supra note 60. One of the hoped-for results of introducing REIT regimes in the United Kingdom and Germany was that property that was initially in poor condition would be taken over by REITs and improved. 2. With regard to property development undertaken on behalf of third parties. In the United States. but even this mild restriction has now been lifted. up to 50% of gross asset value may be directed towards property development. Aside from the letting and leasing of property. Inland Revenue. Neither option is possible under Germany’s REIT regime. p.110 Practitioners had called for an unlimited amount of development activity to be permitted under the UK regime. Furthermore.115 but there are no restrictions on the type of nonqualifying income. REITs in those countries obviously had to be permitted to undertake property development activities for this result to occur. Both property investment and effective portfolio management involve selling properties from time to time.109 Not restricting the services taxable REIT subsidiaries may engage in enables USREITs to provide a wider range of competitive services to their tenants (for example. Permitting property development. the Gesetz zur Schaffung deutscher Immobilien-Aktiengesellschaften mit börsennotierten Anteilen (“the G-REIT Act”) limits a G-REIT’s activities to real estate-related ancillary activities regarding the entity’s own portfolio. 110. should improve REITs’ performance over the long term. supra note 75. REITs are generally not designed as property trading vehicles. Taxable REIT subsidiaries in the United States were at one stage permitted to perform only “customary” real estate services to tenants.111 Gains from the sale of developed properties within three years of completion are taxable. Guidance GREIT 01030. 6. such as pure operating services provided to its tenants (for example. considering the level of risk that normally attaches to property development projects. However. 116. Para. supra note 9. permitting 25% of REIT income to be non-qualifying. National legislators typically do not intend their REIT regimes to provide tax advantages to property developers. UK-REITs can conduct further property development either within their 25% quota of taxable activities or through taxable subsidiaries. However. however. 5% of a US-REIT’s income may stem from non-qualifying sources.35. Due to reform under the Taxpayer Refund and Relief Act of 1999. The scope of activities a US-REIT may undertake through taxable subsidiaries seems significantly broader than that of the GREIT. Retail investors benefit if the quality of the investment is maintained through development.117 Under the UK regulations. The income from those services ultimately benefits the US-REIT and its investors – an opportunity that is not available for G-REIT investors. although this income does not receive the same tax benefits as qualifying income.118 At the same time. 113. Unlike the G-REIT. if a UK-REIT intended from the beginning to retain a building or buildings as investment rental property. Like the G-REIT.Articles In order to justify their tax privileges. the investors that REIT regimes hope to attract are unlikely to be interested in property development projects. it crosses line from ring-fenced to taxable non-ring-fenced activities. as long as the hotel is managed by a third-party manager. for example. Guidance GREIT 4505. in turn. which. The US regime is less strict. at least for REITs’ own portfolios. The United Kingdom is even more liberal. the rules on “owner-occupied” property result in property not being considered part of a REIT’s property rental business if it is leased out to companies in which the REIT holds a controlling interest.113 The US and UK regimes are more flexible: US-REITs can trade property through taxable REIT subsidiaries114 and UK-REITs can do so within their quota of non-qualifying income. therefore. In the United Kingdom. a REIT’s property may be leased to a taxable REIT subsidiary. 111. p. Guidance GREIT 04040. the general scope of activities of such taxable REIT subsidiaries is limited to real estate-related ancillary services. the US-REIT may develop real estate only for its own portfolio. 112 In addition. property development is permitted only when it is related to a REIT’s investment purposes – for example. 14 G-REIT Act. REITs’ core business is typically limited to passive real estate activities. 112. etc. supra note 15. Internet or cleaning services). as the expectation is that they receive income from holding properties. 118. UK and G-REITs are unlikely to be appropriate vehicles due to their borrowing restrictions and high mandated distribution levels. This restriction includes property development. The G-REIT Act. HM Treasury. BULLETIN FOR INTERNATIONAL TAXATION JULY 2010 © IBFD 375 . Berwin Leighton Paisner & DTZ Group. UK-REITs are free to hold owner-occupied property themselves.). Activities for third parties may only be rendered through taxable REIT subsidiaries. 117.
128. 1566. Up-REITs. 120. Cornell. the G-REIT regime is more restrictive than either the US-REIT regime or the UKREIT one in terms of permitted activities. governance issues still arise from time to time in relation to REITs. For example. the Securities Act of 1933 and the Securities Exchange Act of 1994. supra note 121. Cornell. Singer. or affiliated with a REIT or members of its management.5.Articles quota of non-qualifying assets.128 In merger and acquisition scenarios. p. and Down-REITS. p. or the REIT acquiring properties owned by its affiliates or members of its management. 126. These interests are generally convertible into common REIT stock.121 Conflicts might well arise between the original property owners. The latter are generally interested in maximizing their dividends and stock appreciation. supra note 121. Most common are issues surrounding transactions between REITs and their affiliated entities. Fundamentals of modern business (Boston: Little Brown. p. Id. Even though taxable REIT subsidiaries are subject to full corporate income tax. such conflicts of interest are triggered by parties’ different financial or tax interests with regard to a specific transaction. 123. 335 and Cornell.127 Similarly. The United States originally had more restrictive rules regarding permitted activities for taxable REIT subsidiaries. 1586. One such structure is the UpREIT. Chadwick Cornell. 6. “REITs and UpREITs: Pushing the Corporate Law Envelope”. 15. Sec. 2. 1584-1592. the REIT is responsible for the administration and the management of the partnership’s properties as well as for its strategic direction. whereas the individuals contributing property are generally more concerned about tax privileges and diversification. US-REITs as well as their shareholders benefit from the income generated from “synergistic” businesses and enable the REIT to be managed more effectively. Id.122 In an UpREIT structure. an UpREIT holds a direct interest in an “umbrella limited partnership” (this is the “Up” of the name) of which the UpREIT is the general managing partner. also have a say regarding the umbrella partnership’s management. 127. the REIT holds the position of general partner of the limited partnership.9. pp. In spite of these safeguards. 125 Potential conflicts of interest between the limited partners of the umbrella partnership and the REIT’s shareholders may arise from many ordinary business transactions. the sale of property might have severe tax implications for the limited partners. McCall. Some varieties of REITs that have developed in the United States produce heightened opportunities for conflicts of interest. © IBFD . 16 Virginia Tax Review (1996). Furthermore. 119. Id. supra note 9. 121. This restriction deprives investors of a reasonable portion of revenues that could be generated from these kinds of businesses.119 Despite these experiences of reform and its effects on the US market. 13. IRC. The shareholders might want to accept a high cash tender offer. which was developed to circumvent the problem of built-in gains being taxable on the transfer of property to a REIT. who. 126 whereas the shareholders are not exposed to this tax liability and. Russel J. This is because the former property owners and the stockholders in the REIT are following different objectives with their investments. The German rules do not allow REITs to engage in any kind of nonreal estate-related activities. See. owned by stockholders. The real estate industry warmly welcomed this move and some credit the amendment with reviving the REIT market. generally. 124. 1989). Para. supra note 121.123 The publicly listed REIT is. For example. University of Pennsylvania Law Review (1997) 145. generally involving differing economic or tax concerns. and the common REIT shareholders. but it relaxed these via the Taxpayer Refund and Relief Act of 1999. now holding interests in the umbrella partnership.. which might turn out to be disadvantageous for the G-REIT’s competitiveness and performance in the long run. 1578. in turn.120 Generally. who must recognize built-in gains released on the sale. conflicting tax interests may arise regarding the paying-down of umbrella partnership debt from property acquisitions with REIT funds or regarding merger and acquisition activities. whereas the limited partners might favour a stock swap. it can easily happen that the stockholders’ and limited partners’ interests are diametrically opposed. there may be conflicting interests with regard to office space or services provided by a REIT to its affiliates or by the affiliates to the REIT. 125. p. p. “Understanding REITs. UpREITs do not directly hold interests in real assets. not even through a taxable service subsidiary. p. Robert W Hamilton. Instead. therefore. manage or lease that REIT’s properties. However. directly owns interests in property. the German legislators opted for more restrictive regulations. As such. 122. 1581. the interests of the initial property owners are likely to coincide with those of the stockholders to a considerable extent. in turn. Although there are no comparable rules on owner-occupied properties under the German regulations. REIT governance and conflicts of interest There are various disclosure and publication requirements that deal with conflicts of interest under the US securities laws – in particular. contributed to the partnership by their owners in exchange for limited partnership inter376 BULLETIN FOR INTERNATIONAL TAXATION JULY 2010 ests. the original property owners may have different interests with respect to some transactions.. The umbrella partnership (also referred to as the REIT’s operating partnership). and the Tax and Business Decisions Surrounding Them”. through the REIT as general partner. p. might favour a sale that is perceived as economically disadvantageous by the limited partners. issues may arise if entities owned by a REIT. even though it is worth less in value. 704(c). The Act amended the regime so that taxable REIT subsidiaries can now provide both “customary” and “non-customary” services to tenants.124 If or when the UpREIT limited partners make use of their right to convert their limited partnership interest into common stock of the REIT.
courts should apply © IBFD a different standard of review.143 In the US context. Inc. they now choose the state where they are located. v. v. 141. for example. it is important to remember that many of the controlling individuals are professional or experienced real estate investors pursuing their own financial interests. Id. Lynch Communication Sys. the directors of a corporation acted on an informed basis. when reviewing decisions of UpREIT fiduciaries. 1989 WL 214477. The fiduciary position of the board members towards the stockholders is recognized as a fundamental concept of corporate governance. Aronson v. p.e. Unitrin. 130. (1994) 638 A. 144.) and Harden v. Inc. (1995) 651 A. before it may take advantage of the business judgement defence. Ch. Nevertheless. the NAREIT has adopted a code of ethics. be applied under the “entire fairness” test in cases where there is actual evidence that the fiduciaries took a decision conflicting with the shareholders’ interests. 138. QVC Network.129 2. Judicial review in cases of conflict of interest In a small number of cases. supra note 9.). since the board members have fiduciary duties towards the stockholders. (1989) No CIV. p.2d 34. Oct. Chris-Craft Industries. (1989) No CIV. Cornell. v. they effectively concern the decisions of corporate fiduciaries. Lewis (1984) 473 A. 136. Id. See Paramount Communications.132 This also transfers the burden of proof from the board to the plaintiff. due to the many potential conflicts with regard to UpREIT governance and the popularity of this structure. 954 (Del. the UpREIT structure is far more complex and gives rise to more potential conflicts of interest than more straightforward corporate entities. JH-89-2503. 1989 WL 214477. 129. v. 2d 651 (Del. Property Trust of Am. 27) for examples of cases where courts applied the general principles of review applied in corporate governance litigation to REITs. 139. The board must show “good faith and reasonable investigation” in reaching a decision. Eastern States Pub. in good faith and in the honest belief that the action taken was in the best interest of the company”.. Blasius Industries v. 134.2d 533.137 In such circumstances. Some commentators consider that.Articles which would allow them to further defer gains instead of having to recognize them on the sale. Inc. under which the court presumes “that in making a business decision.).). at 3 (D. 44 (Del. Inc. due to the unusual characteristics of UpREITs. 141 However. 712 (Del. 1600. A much stricter standard of review may. (1993) 637 A. Avoiding conflicts In practice. McCall. Up to the mid-1990s. 710 (Del. Atlas Corp (1988) 564 A.). Cornell. REITs try to avoid potential conflicts of interest by appointing boards of trustees or directors that can be considered to be independent in an effort to balance any conflicting interests between the REIT management and the shareholders. The original intention and policy reasons proclaimed when enacting the early REIT laws were. Inc. 44 (Del.) and Kahn v. Society for Sav. See. (1971) 285 A.2d 805.10.136 For example.) and Realty Acquisition Corp. Md. Technicolor.2d 1361. Additional tests and burdens of proof are applied on the board in the case of takeover bids. as well as the proportionality and reasonableness of its decision. Inc. 705. p. 812 (Del. in particular. Blasius Industries v. Md. QVC Network. however. the board bears the burden of proof and must demonstrate a “compelling justification for such action”. Arnold v.2d 437 (Del). many UpREITs were incorporated in Maryland. p. i. 1115 (Del. where the courts applied the general principles of review applied in corporate governance litigation to REITs.139 However. courts have treated REITs like any other body corporate. Weinberger v. 135. which has to prove the “entire fairness” of the transaction in terms of fair dealing as well as financial and economic considerations. v. as happened in Blasius Industries v. Id. (1996) 678 A. reverting to the standards of review developed in corporate litigation. 1588.. See Paramount Communications. 133. American Gen.2d 1156. Corp. however. (1985) 493 A.9 (Del. Available at www. 140. supra note 121. Id. UOP. the board might try to manipulate the shareholders’ voting rights by amending the by-laws or increasing the size of the board. at 3 (D. 27). 1567.).com. Serv. 16. Property Trust of Am. 1162 (Del. (1995) 663 A. Bancorp. supra note 121). 132. middle-class investor. Inc. (1983) 457 A. boards have been considered to have a broad scope of discretion in making decisions.133 Generally.Ch. Although most cases are rooted in the federal and state tax laws.2d 946. supra note 121. to further the cause of the small.134 In these circumstances. 142.130 Generally. v. because it still is the “most persuasive precedent” in the area of state corporate law (see Cornell. 143.) and Realty Acquisition Corp. Ch. p. 1595. Id. JH-89-2503. 2.142 Many institutional investors as well as underwriters see the formation of an independent board of directors as a necessary precondition for publicly listing a REIT. (1923) 122 A. more litigation can be expected in the future. Delaware serves as a good example.135 Another scenario where courts apply an increased level of scrutiny is where decisions are intended to affect or impede the shareholders’ voting power. Mesa Petroleum Co. Atlas Corp (1988) 564 A.11.131 One rule that is likely to be applied to business decisions of corporate fiduciaries is the “business judgement rule”. Oct. Inc. BULLETIN FOR INTERNATIONAL TAXATION JULY 2010 377 . Atlas Corp.2d 34.. v. Nevertheless. 540 (Del. 131. (1993) 637 A.) and Unocal Corp.144 In practice. Because of the relatively small number of UpREITs.reit.2nd 701. courts in the United States have addressed conflict of interest issues in REIT structures. 1372 n. Co.) and Schnell v. 2d 651 (Del. a fair balance has to be found between the common stockholders’ interests and those of the limited partners who originally contributed their assets to the umbrella partnership with the objective of saving taxes. Instead. Inc. there is little litigation to date dealing specifically with this structure. the burden of proof is placed on the board.) and Cinerama.2d 1110. a more frequent and higher level of scrutiny should be applied to the board’s decisions.138 Courts seem to have applied these doctrines to REITs easily enough. which requires member REITs to have a largely independent board of trustees or directors. When assessing the board’s fiduciary duties. With favourable legislation being enacted in other states. in relation to conflicting interests between the board or a controlling limited partner and the REIT shareholders. 137.140 The significantly higher potential for conflicts of interest that the UpREIT structure presents when compared to a standard corporation make it seem inappropriate to apply the “business judgement” rule to fiduciaries of UpREITs automatically. Inc.
it is hard to see how REITs could ever reach their previous heights.Articles REITs also incorporate provisions in their by-laws requiring that. indeed. The UK and German REIT regimes were introduced with high expectations.148 As with any corporation. decisions regarding the sale of properties must be made by independent trustees or directors. unlisted REITs should examine the North American Securities Administrators Association’s policies on oversight and administration with regard to borrowing and investment practices.156 where property prices in urban areas are expected to continue to rise for at least 145.146 For example. see Fraser Hughes. but fundamentally the regimes are sound. but it is unlikely that real estate prices will ever reach 2006 levels again. supra note 33. it seems clear now that the heyday of REITs is over. p. That is. the individual partnership agreements of a REIT structure may need to be shaped differently to satisfy the individual interests in view of the varying financial and tax situations and interests regarding certain properties. 150. 23 June 2009. once practitioners start developing more advanced REIT structures with affiliated companies. 2. the United Kingdom and Germany might have to face governance issues similar to the ones experienced in the United States. Future international REIT developments Although real estate investment trusts have become an essential part of the market for indirect real estate investment worldwide. Id. available at www. 3. drawn up by the government. the legislation provides for a basic structure.154 Forecasts are more subdued now. 155. McCall. but the primary reason for the success of REITs was the success of real estate. © IBFD . The structural benefits of the REIT model certainly played a large role in allowing investors to access the extraordinary profits that were available. 153. 322-323. 336. 16.152 Apart from relatively stable and above-average returns over the last decades. “PanEuropean REIT? – A Long. The German Stock Corporation Act also incorporates a Corporate Governance Code (Deutscher Corporate Governance Kodex). Id. p. the establishment and effective operation of independent bodies to review the REIT’s accounting practices and policies are crucial. the problem of possible conflicts of interest was barely discussed in consultations for an appropriate REIT format in the United Kingdom and Germany.150 which companies are recommended to comply with. Their tax advantages mean that they are usually the most favourable vehicle for property investment. in the previously noted scenarios giving rise to potential conflicts of interest. See generally Noriel Rubini. 330 and McCall. especially in the United Kingdom. 154. property continues to be a growth sector.151 Regardless of real estate and economic business cycles and downturns. 153 there are a number of further multifaceted benefits inherent in this structure that make it particularly attractive. 148. it seems clear that they will remain. These entities must ensure their compliance with the laws governing capital markets and deal with conflicts of interest in the same way as any other corporation of their type. Sec. 147 Aside from compliance with applicable SEC rules and provisions of state business codes. Ernst & Young.155 but the inherent benefits of REITs remain unchanged. considering that the UK and German REIT regimes have been operating for not quite three years. the fact that REITs will never again be the runaway profit vehicles that they were for the decade from 1995 to 2005 does not mean that there is no future at all for REITs.com. United Kingdom House of Lords Select Committee on Economic Affairs. REITs thrive wherever there is money to be made from property investment. and the regimes’ initial performance was very encouraging. which became a real estate bubble. rather than a star player. However. However. the REIT as the general partner of the Up or Down-REIT partnership may even be barred from selling specific pieces of property contributed to the partnership. Most developed economies are experiencing steep declines in property values.com). 152. Both the UK and German regimes perhaps could be revised to encourage investors to embrace the new vehicles more enthusiastically. and it is. However. Private. 147.12. For example. as it reflects the true nature of real estate as an investment. and the current slump will end eventually. 156. REITs must also ensure that they comply with any relevant stock exchange regulations (for example. Long Road” (2005. but in some countries that are at a less advanced stage of development. 18. Nevertheless. better that they should not. McCall. p.com). 151. UK and German cases REITs in the United Kingdom and Germany are subject to the same corporate governance principles as any other major company in those jurisdictions.nareit. 146. This absence might be due to the fact that the legislation itself only sets the basis for REITs. NAREIT. Singer. On future developments of REITs in Europe. Essentially. supra note 9. available at www. p. compound annual total returns in per cent. Real estate prices are cyclical. December 1976 – December 2006 at www. Singer. Post-bubble. The role of REITs is likely to change to that of a quiet achiever. it will take some time until the first REIT cases involving with conflicts of interest and governance are heard. 16. 161 AktG. p. Outlook and Concluding Remarks 3. supra note 127. “Are There Bright Spots Amid the Global Recession?” (6 August 2009. the US Stock Exchange and New York Stock Exchange regulations) which require shareholder approval for certain transactions. Paras. 149.forbes.149 2. supra note 127.145 Moreover. consisting of just one entity.1. p.epra. they are still one of the less understood 378 BULLETIN FOR INTERNATIONAL TAXATION JULY 2010 areas within commercial real estate. The astounding success that REITs enjoyed during the late 1990s and the first half of the 2000s was closely tied to the real estate boom. supra note 9. “The Finance Bill 2009” (Third report of session 2008-2009). Perhaps surprisingly. but this development should be seen as positive. supra note 9. One example is China.
“Global REIT Report 2008” (October 2008. REITs are experiencing a minor revival as vehicles for purchasing troubled mortgage assets.e. p. but. Id. New Zealand Inland Revenue. in fact.159 In the United States at least. available at www.157 China has been considering enacting a REIT regime for some time now and.pwc. an overvaluation of the assets once their long-term performance becomes clear.2. For example. and thereby receive both tax benefits and also a discount on financing costs. Deutsche Bank Research (November 2006. companies and trusts that invested primarily in property were excluded from the proposed regime:165 it was felt that whilst New Zealanders needed encouragement to invest in debt and equity securities. Since 1 October 2007. Subparts CP and HL of the Income Tax Act 2007 now address the income of PIEs. The main reasons are probably twofold. Although. Subpart OB Income Tax Act 2007. As a result.com). Savings Investment. it is not clear whether they will be successful ultimately.161 Furthermore.163 Full imputation is as close as a corporate tax system can go to the impractical ideal of full integration of company and dividend taxes. the fact that REITs are being used for this kind of structure suggests that innovation in the REIT market is far from over. 168.160 Although these structures have the potential for great success. available at www. there has been little call in New Zealand for the development of a specialized property investment vehicle. 165. “Worldwide Real Estate Investment Trust (REIT) Regimes: Country Summaries”(June 2009. it should be easy to purchase troubled mortgage assets from banks and other financial institutions.com). Kate Berry. For example. Essentially. Whilst it perhaps did not intend to do so. First.166 Global REIT surveys of the kind published by accounting firms and industry bodies tend to treat New Zealand as not having a REIT regime. in turn. available at www. rather than through a collective investment vehicle. Ernst & Young. 169. are putting their own plans for REIT regimes into action. For example. in practice. property-owning companies in New Zealand probably appear to suffer less from both corporate lock-in of profits and double taxation of company profits than do property-owning companies in many jurisdictions: hence there is little if any demand for a specialized property investment vehicle. “Listed property sector ‘starved for cash’” (13 May 2009. 159. Secondly. Property investment in New Zealand does not seem to have suffered from the lack of such a vehicle. “Was Europa von US-REITs Lernen Kann”. this absence leads in general to over-investment in land. in theory. the NZ-REITs referred to in Anne Gibson. 8-9. The tax benefits of REITs mean that they will always be the best vehicle for real estate investment. 3. 161. “Property prices soar in China and analysts predict 20% increases by 2010” (13 August 2009. losses from Land PIEs’ land investments are ring-fenced from Land PIEs’ other investments.com). not necessarily property investment.dbresearch. albeit almost by accident. 163.168 presumably on the basis that the PIE regime allows for essentially similar entities to be created. “Commentary on the Taxation (Annual Rates. it appears that these plans will come to fruition. Land PIEs receive the same tax benefits as other PIEs.169 thereby facilitating market access or 157. For example. Unlike the position in a number of other jurisdictions.164 The purpose of the PIE regime is to encourage smaller investors to partici© IBFD pate in share ownership. Subpart LE Income Tax Act 2007. by buying troubled assets at a discount and selling them when the market recovers. The outlook for REITs The US example shows how important a responsive regulatory environment is for growth in REIT markets. 164. 3. EPRA.com). subtract these credits from tax otherwise payable on dividends.bankinvestmentconsultant. New Zealand did enact something very like a REIT regime two years ago. 167. New Zealand has had a Portfolio Investment Entity (PIE) regime. “China REITs – What’s the Latest?”. approximate the effects of holding shares directly. available at www.3. available at www. as far as tax is concerned.162 That is. the draft regime was eventually amended to allow “Land PIEs” – PIEs that have one or more share classes that invest primarily in property holdings.com).dsnews. 162. by and large. PIEs are tax-preferred collective investment vehicles that. New Zealand has no comprehensive capital gains tax.propertywire.de). Brad Markoff and Mabel Lui. Nevertheless. 160. New Zealand’s PIE regime was introduced in the Taxation (Savings and Miscellaneous Provisions) Act 2006. 1. For example. the “discount” price for which such REITs can purchase troubled assets may well turn out not to be a discount at all. other maturing economies. The New Zealand Herald. for investors.ey. but. by enacting the PIE regime. such as India and Pakistan. available at www.Articles the next year. as at the beginning of 2010. New Zealand employs a full imputation system for taxing companies. The story of US-REITs has been a history of cycles. New Zealand enacted a REIT regime. DLA Piper Newsletter (January 2009). although the PIE regime covers a good deal more than property investment. New Zealand has an interesting example of this kind of national modification. Entities that refer to themselves as REITs sprang up quickly once the PIE regime was enacted. available at www.158 Similarly. and Miscellaneous Provisions) Bill”. Shareholders. investors in Land PIEs are placed in a similar position to direct investors in property. Nevertheless.167 although occasionally some surveys include New Zealand REITs. i.nzherald.co. Under initial drafts of the PIE regime. Phases of increased growth have been preceded by favourable regulatory changes. “REITs reclaim stage as way to cash in on crisis” (31 July 2009. companies may pass credits for all corporate-level tax to their shareholders. such organizations are reluctant to sell at large discounts because of the knock-on effect such sales would have for the valuations of the assets they continue to hold. “PennyMac IPO exposes REIT weaknesses” (4 August 2009. If structured correctly.nz. BULLETIN FOR INTERNATIONAL TAXATION JULY 2010 379 . There are some restrictions on Land PIEs over and above those on other PIEs. Quasi-REITs The basic REIT blueprint has been used to encourage investment in assets other than real estate. Tobias Just. such REITs can be eligible for government funding via the Troubled Asset Relief Program. 166. However. pp. they did not need any encouragement to invest in property. 158. supra note 71 and PricewaterhouseCoopers. Adam Weinstein.
“The Finance Bill 2009” (Third report of session 2008-2009). The German prohibition on REITs investing in most residential property seems counterproductive. a relaxation of the regulations governing the UK-REIT would encourage more property companies to convert. part cash”. Ernst & Young. the REIT boom in the early 1990s was spurred on by the introduction of UpREITs and regulatory changes permitting REITs to provide non-customary services through their taxable REIT subsidiaries. 249. Both the United Kingdom and Germany seem to be addressing defects in their REIT regimes. at least to some extent. as the US case reveals. when REITs were permitted to conduct (taxable) non-qualifying activities without losing their REIT status. Legislating for a regime providing for private REITs is a possibility. a relaxation in the provisions relating to distribution of profits has to some extent eased the path for US-REITs and allowed them to try to take advantage of new opportunities arising out of the mortgage crisis that started in 2007. Para. some blame must fall on poor regime design. further legislative changes can be expected both in the United Kingdom and Germany to encourage growth in the REIT market. The success of single-property REITs in the United States makes this requirement seem notably perverse. In the case of Germany. 23 June 2009. In the United Kingdom also.174 Otherwise. 175 170.nytimes. rather than what critics have identified as the more pressing problems with the regime.173 Germany. should reassess its legislation. since it is at a disadvantage in relation to the UK-REIT industry because of the United Kingdom’s reputation and long tradition as a financial centre. 18. 172. private REITs could have provided an attractive complementary investment option for both markets. Although the main reason for the relative lack of success of the two European regimes is certainly the global recession and a general distaste for real estate investment. Savills L & P Limited. 173. More recently. In particular. supra note 7.170 The UK and German regimes seem comparatively restrictive and unresponsive to changing market conditions.Articles operating conditions for REITs. the UK rule providing that REITs must hold at least three properties seems to do nothing other than block opportunities for investment and growth. Provided that the income in question has already been taxed in the state in which it arose at a rate of 15% or higher. New York Times (25 January 2009. those companies will become takeover targets by large and efficient REITs that will finally dominate the market. 380 BULLETIN FOR INTERNATIONAL TAXATION JULY 2010 © IBFD . p. 174. “Some REIT dividends are part stock. Moreover. in particular. Id. Germany has addressed this issue with the new Sec. although so far officials have focused on minor matters. Along similar lines. 171. 175.171 The United Kingdom also appears to be re-examining some aspects of its regime. 19(a) of the G-REIT Act. the UK and German gearing limits seem too restrictive. There was a significant increase in REIT investment after 1986.172 In the medium term. If Germany wishes to compete with other European and international REIT models over the long term. Similarly.com). Vivian Marino. a number of industry participants identified the quasi-double taxation of REIT income generated from foreign real assets as a problem. it must offer features that persuade investors to choose the G-REIT over other structures. United Kingdom House of Lords Select Committee on Economic Affairs. which partially eliminates this double taxation. supra note 33. available at www.
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