Real Estate Investment Trusts

During the 2019 Budget Speech presented on 22 October, the Finance Minister stated that discussions regarding Real Estate Investment Trusts (REITs) are close to being concluded with the aim that the administrative, fiscal and regulatory changes will be implemented to enable REITs to be listed and traded on the Malta Stock Exchange.

Ahead of a possible consultation process with industry stakeholders and the increased media coverage on REITs in the months ahead, an explanation to retail investors on the concept and benefits of these financial instruments should be of interest to investors generally.

REITs are simply companies whose sole business is owning and operating income-producing real estate. REITs invest in various types of properties and provide investors with access to a diversified real estate portfolio.

REITs may invest in either residential property developments or commercial properties. The typical commercial properties forming part of a REIT portfolio may include office facilities, shopping centres, industrial space and warehousing as well as hospitality offerings (hotels and other tourism related properties).

Some may argue that we already have various companies listed on the Regulated Main Market of the Malta Stock Exchange offering investors the possibility of investing in different types of properties namely Plaza Centres plc, Tigne’ Mall plc, Main Street Complex plc, Malita Investments plc, Malta Properties Company plc, MIDI plc and Trident Estates plc.

However, REITs are generally defined as ‘globally recognised tax efficient structures for investment in real estate’.

In fact, to qualify as a REIT and benefit from the tax incentives, a company must meet a number of requirements and from research on the subject matter, it is evident that each jurisdiction has a number of similar as well as distinct features.

REITs were initially created in the US in 1960 and since then, more than 30 countries around the world have established REIT regimes. They were introduced across Europe more recently. The UK REIT regime was originally launched on 1 January 2007, although there have been a number of changes in subsequent years which helped most listed companies that could qualify as a REIT to proceed with such a converison.

The rules of REITs in most countries stipulate that the company must have a certain percentage threshold of its total assets in real estate (in some cases 75%) and must receive a minimum percentage threshold of its gross income from rents from property, interest on mortgages financing property or from sales of real estate. More specifically, the main requirement is that the company must stick to a minimum dividend payout ratio. In most cases, this ranges between 75% and 90% of a company’s taxable income in the form of shareholder dividends each year. This is also similar to the current practices of four of the companies listed on the MSE, namely Plaza Centres plc, Tigne Mall plc, Main Street Complex plc and Malita Investments plc.

Some countries also require that a company operating as a REIT must have at least 100 shareholders and none of the shareholders can hold more than 50% of the shares. Moreover, in some countries there are also regulations for companies to maintain certain gearing and financial ratios. For example in the UK and also in Ireland, a REIT must have its finance costs covered at least 1.25 times by its profits. Also in Ireland, a REIT must maintain a loan to value ratio up to a maximum of 50%.

REIT structures are unlikely to be suitable for companies mainly focused on property development activity especially when it comes to satisfying the requirement for a high dividend payout ratio. In some countries such as Japan, property development within a REIT structure is prohibited. In recent weeks, I provided an overview of those companies listed on the MSE owning and administering commercial properties which are very similar to REIT structures (such as Plaza Centres plc, Tigne Mall plc, Main Street Complex plc and Malita Investments plc) and those whose current main area of activity is in property development (such as Malta Properties Company plc, MIDI plc and Trident Estates plc). However, it is evident that once a company develops its main property assets it will then behave more like a commercial property company by generating income from its property portfolio and distributing dividends to shareholders. It is therefore important that when the requirements for Maltese REITs are being drawn up, they cater for companies to convert from their present structure to a REIT.

If a company satisfies the requirements and qualifies as a REIT, it will receive special tax considerations. The tax treatment on the REIT itself and also at shareholder level differ widely from one country to the next and this will surely be the main area of focus once the proposed rules of Maltese REITs will be published.

REITs have become an increasingly popular vehicle for real estate ownership in many countries possibly due to a number of benefits such as (i) easier access to property investment opportunities compared to purchasing a property directly; (ii) a REIT is a tradeable investment on a stock exchange which makes this more liquid compared to direct investment into property; (iii) retail investors can access a diversity of property investments (either by buying into one REIT or a group of REITs) with a relatively small outlay compared to the difficulty in achieving this diversification buy buying property directly; (iv) REITs provide a regular income stream due to the requirement of a high dividend payout ratio with lower transaction costs compared to direct property investments.

An interesting exemption within the REIT rules in the UK is that REITs are exempt from the free-float rule requiring 25% of the issued share capital to be held in public hands. This has reportedly proved particularly attractive for those REITs where a small number of institutional investors own a large stake in a REIT and especially, where they are likely to hold on to such an investment for the long term and therefore do not require significant levels of liquidity on the secondary market. This could be an interesting aspect for the MSE and the regulators to consider given the current restrictions within the MFSA Listing Rules which may be inhibiting certain large companies to access the equity market.

In recent years it was evident that a growing number of property companies are using the regulated main market in Malta for an equity listing and therefore the introduction of rules for REITs is a very timely initiative.

Hopefully, sufficient time will be available for a consultation process with industry stakeholders in order to ensure that the new rules for REITS will be well received and will help to continue to attract more companies to the regulated main market of the MSE.

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