After decades of opposing industry efforts to establish real estate investment trusts in the United Kingdom, the British government will permit the investment vehicle beginning this month. The new year will likely kick off with a half dozen big public companies converting to REIT status and another half dozen UK REITs forming in the coming months.
British officials hope REITs will attract more capital and strengthen real estate companies. The markets seem to agree; real estate stocks have been rising in anticipation of the REIT conversion.
American investors are already bullish on the new UK REITs. In the past, CalPERS, the giantpension fund, invested nearly all of its real estate allocation in U.S. properties. Anticipating the arrival of more REITs abroad, the fund has placed $800 million with portfolio managers who will invest overseas, and the foreign allocation will rise to $2 billion by 2008.
The British government had resisted REITs, fearing a tax drain. In exchange for paying out most of their earnings in the form of dividends, REITs typically pay no corporate taxes. But property companies in Britain were already finding ways to dodge the taxman. Many big companies moved their headquarters to tax havens, such as the Channel Islands, where they avoid paying corporate taxes.
Under the new rules, UK-based REITS won't pay corporate taxes. Instead a company must pay 2% of its assets as a one-time fee for converting to REIT status. “It's a way for the government to get their hands on some money that they may never have gotten otherwise,” says Tim Wheeler, chief executive of Brixton PLC, which is converting to REIT status. Brixton is the largest warehouse company in the UK, owning and managing $4 billion dollars worth of properties.
Because UK REITs must pay out 90% of their income as dividends, their shares should attract pensions and income-oriented investors, experts say. U.S. investors who are familiar with REITs are likely to feel comfortable with the UK vehicle. “With the new REIT structure, the cost of capital should be reduced in the UK,” explains Wheeler of Brixton. “More development could take place.”
REITs are already active in France and the Netherlands. Italy and Germany are scheduled to permit REITs later this year. REITs are also growing in Japan, Singapore, and Hong Kong. “Of all the major property markets, most already have REIT structures, or they are thinking about putting them in place,” says Fraser Hughes, research director of the European Public Real Estate Association, a trade group in Schiphol, The Netherlands.
At first, the new UK REITs are not likely to have a big impact on U.S. markets, says Patrick Sumner, head of property equities for London money manager Henderson Global Investors. The UK companies won't rush to buy REITs outside their home base, he says. But the conversion to REIT status has already boosted stock prices of UK property companies.
“In the past, the British property shares have tended to trade below their net asset values because they were tax inefficient,” says Sumner. “Because investors are anticipating that the tax disadvantage will be eliminated, the shares are climbing.”
The new UK REITs will be substantial companies. British Land Co. PLC owns an investment portfolio that is worth more than $20 billion in offices and retail space. Other big companies that will form REITs include Land Securities PLC and Great Portland Estates PLC. Most of the big British companies hold diverse portfolios.
The British REITs may gradually come to emulate their American cousins, focusing on a single sector, says John Kriz, managing director of real estate finance for Moody's Investors Service. The arrival of the UK REITs is goodfor public real estate markets around the globe, says Kriz. “As countries adopt REITs, investors will gain more confidence in the concept and be willing to try the shares.”