The impact of REITs on listed property

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12 Apr 2013

The most active sector on the Johannesburg Stock Exchange (JSE) over the past 12 months, with a market capitalisation of some R222 billion, South African listed property is poised to undergo a significant change.

The most active sector on the Johannesburg Stock Exchange (JSE) over the past 12 months, with a market capitalisation of some R222 billion, South African listed property is poised undergo a significant change.

Bringing it in line with international standards, the JSE published new Listing Requirements on 28 March 2013 that will facilitate the South African Real Estate Investment Trust structure, or SA REIT (pronounced “essay reet”).

National Treasury formally published REIT tax legislation for South Africa on 25 October 2012.

The SA REIT will become a reality from 1 May 2013, after more than a six-year journey.

It is one of the most flexible REIT regimes internationally and a significant development for South Africa’s publicly traded real estate sector.

Like existing listed property structures in South Africa, REITs own and operate income-producing commercial property and the SA REIT provides a simple, clear tax structure.

More than 25 countries in the world use a similar REIT model like the US, Australia, Belgium, France, Hong Kong, Japan, Singapore and the UK.

“Because the SA REIT dispensation provides many benefits, the foremost of which is tax certainty, it is likely that all qualifying South African listed property entities will make application to the JSE to become a REIT,” says Estienne De Klerk, chairman of the SA REIT Association committee and executive director of Growthpoint Properties.

This means there could be around 30 SA REITs by this time next year.

De Klerk says the JSE has indicated that while the effective date of the new REIT Listing Requirements is 1 May, early implementation by applicant issuers will be permitted.

“The REIT structure is in line with international best practice and having a globally understood structure will make our listed property sector much more attractive to foreign investors.”

According to Patrycja Kula business development manager at the JSE, the tax advantages of the new structure will also make the listed property sector much more attractive to local investors.

“When South African listed property funds convert to this system South Africa will be the eighth largest REIT market,” she says.

The listed property sector, spearheaded by the SA REIT Association, actively campaigned for the SA REIT structure to align it with global best practices.

It worked closely with National Treasury, South African Revenue Services, the FSB, JSE and Association of Property Unit Trusts to achieve this goal. The aim was to provide simplicity, transparency, flexibility and tax certainty.

“The SA REIT achieves all these goals and it is an internationally recognised structure.

“It is flexible enough to adapt to various models while encouraging best-of-breed practices and creating tax certainty,” says De Klerk.

What this means for existing listed property entities in South Africa?

De Klerk explains there are two forms of listed property investment entities in South Africa: property loan stocks companies (PLSs) and property unit trusts (PUTs).

Estienne De Klerk, chairman of the SA REIT Association committee and executive director of Growthpoint Properties says, should all eligible SA listed property entities be listed as per the SA REIT requirements, it is expected to place South Africa in the top 10 REIT jurisdictions in the world.

Both will be able to adopt a regulatory framework set out by the JSE and qualify to list on the REIT board of the JSE.

The structure is flexible and allows SA REITs to be managed internally or externally, and caters for different equity structures that may exist, such as A- and B- linked units of various property loan stock companies.

He says the JSE has set out simple rules to list as a REIT.

First a SA REIT must own at least R300 million of property and must keep its debt below 60 percent of its gross asset value.

It must also earn 75 percent of its income from rental, or from property owned or investment income from indirect property ownership.

He says it must have special measures in place to monitor risk and must not enter into derivative instruments that are not part of the ordinary course of business.

Finally, a SA REIT must pay at least 75 percent of its taxable earnings available for distribution to its investors each year, he points out.

PLSs and PUTs will need to apply to the JSE to be listed on the REIT board, showing they comply with all the requirements and committing to the ongoing obligations, by 1 July 2013.

Once the PLS or PUT is listed as a REIT on the JSE it will be known as a ‘Company REIT’ or a ‘Trust REIT’, respectively.

It will then qualify for the REIT tax dispensation provided under the new Taxation Legislation Amendment Bill Sec 25BB.

The SA REIT tax dispensation

This new tax dispensation means a SA REIT can deduct all distributions paid to shareholders or linked unit holders as an expense.

So, if a REIT pays all its distributable earnings to shareholders, it shouldn’t have to pay any tax.

“It becomes a conduit for net property rental income and provides investors an investment alike to direct ownership of the underlying property,” says De Klerk.

When a SA REIT sells a property for it doesn’t have to pay Capital Gains Tax (CGT) on any profit from the sale.

Also, shareholders of an SA REIT won’t pay Securities Transfer Tax (STT) on buying or selling SA REIT shares.

South African investors will receive gross distributions from a SA REIT without the 15 percent dividends tax being levied against the distribution.

But investors will have to pay tax on the distributions at their applicable marginal income tax rate when they include it in their taxable income.

This also provides investors the opportunity to use debt effectively to fund the acquisition of their REIT investment on a pre-tax basis, he says.

If invested in SA REITs as part of a RA or pension, provident and preservation fund, investors effectively pay no tax on dividends.

Foreign shareholders of SA REITs will be levied a dividend withholding post 1 January 2014 – the current rate is 15 percent or the applicable double tax agreement rate could apply. 

Investor impacts

To the extent that the existing investor invests in a new SA REIT, De Klerk says nothing will change in practice for investors.

For property loan stock company shareholders, the only difference is the nature of the company’s distributions the investor receives.

When the company becomes a REIT, these distributions will change from ‘interest’ to ‘rental income’, in the form of a taxable dividend.

“Existing investors in a PLS should have the opportunity to vote in a general meeting on the resolutions needed for the company to list as a REIT on the JSE,” says De Klerk.

Once the company is listed as REIT, shareholders will be notified and there will be no further impact on investors, he says.

First a SA REIT must own at least R300 million of property and must keep its debt below 60 percent of its gross asset value.

For existing investors in PUTs, there will be no impact. From 1 May 2013, these property unit trusts are automatically considered a ‘Trust Reit’ and listed on the JSE REIT board.

Performance

“There will be no direct impact on the performance of converting listed property counters,  importantly there is no entry tax charge for converting to the SA REIT,” says De Klerk.

The listed property asset class has notched up stand-out performance in South Africa over the past 10 years.

It has outperformed all other local asset classes - equity, cash and bonds - and also outperformed REITs from the developed world.

Should all eligible SA listed property entities be listed as per the SA REIT requirements, it is expected to place South Africa in the top 10 REIT jurisdictions in the world.

This will put the sector more firmly on the radar of international investors and boost its representation on global REIT indices.

“What makes listed property a distinctive investment class is that it gives investors two ways to beat inflation – capital investment growth and regular rental income distributions,” explains De Klerk.

He says this also makes it an important diversifier in any investment portfolio.

The advent of the SA REIT will also help investors to measure up the different SA REITs.

According to De Klerk, the new sector umbrella body, the SA REIT Association, is compiling best practice accounting disclosure and reporting standards.

“This will improve disclosure in the sector, and make it easier for accurate comparison of different SA REIT counters,” he adds.

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