The SFC has published its code on real estate investment trusts (REITs), opening the way for the Hong Kong market to follow Singapore's lead. The new code includes several amendments to the draft version released this March. The consultation period that followed was initially set to last four weeks, but was extended to six at the request of market participants. In total the SFC received 52 submissions from a wide variety of professionals.
Changes to the code have been made in four main areas.
Geographical restriction to Hong Kong, an described by some in the industry as a 'deal breaker,' has been retained. According to the SFC, this was the most difficult issue, but it has chosen to maintain the provision.
"In the early days of REITs in Hong Kong there are sufficient assets here for the creation of viable and attractive REITs," comments Anthony Ryan, vice president of real estate investment banking at JPMorgan. "I do feel that this will be relaxed, probably within 12 to 18 months, as the market will mature very quickly. When and if this happens the likely route will be to say a certain percentage of the REIT can be invested abroad, rather than specific countries."
And indeed, the SFC has agreed to set up a task force to review the provision, as well as examine the minimum benchmarks REITs should set themselves when investing overseas.
Many of the submissions to the SFC included comments on the tax structure of REITs. The SFC has accepted these and all REITs will now be structured as trusts and be allowed to hold the property through a special purpose vehicle (SPV). This means that REITs will not be subject to property tax, but to profits tax instead.
"It's very positive that the tax issue has been resolved," Ryan adds. "It puts them on a level playing field to other vehicles through which investors get exposure to property. The most important thing is that REITs are not discriminated against in terms of tax. It would have been a big issue if this change had not been made."
Ryan goes on to argue that further tax breaks would have made REITs more attractive and helped develop the market that much faster. However, making REITs exempt from stamp duty, for example, would have meant involving the tax authorities. This would have delayed the implementation of the code.
"Now's the time for REITs in Asia," Ryans states. "Japan has them, as does Singapore. Taiwan introduced regulations just last week and there are calls for more appropriate REIT rules in Korea. So I don't think they should have waited any longer, particularly in this low interest rate environment. REITs will be very good for the liquidity in the commercial property market in Hong Kong, which can only be a good thing."
All REITs will be listed. This is viewed positively by Ryan, who feels there would have been problems with redemptions of unlisted REITs. An unlisted REIT could be forced to sell a large amount of assets for a small amount of redemptions at a time when the property market could be depressed. "For a product designed for the retail investor requiring all REITs to be listed is only sensible," he says.
On operational issues, the SFC has agreed to allow the management company freedom to choose between internal management and external management. The borrowing limit has been raised to 35% of the gross value of assets, from the original proposal of 35% of the net value.
The dividend payout will be reduced from 100% to 90% of net income after tax. This came after respondents called for the payout level to be set at between 50% and 90%.
These are all viewed positively by Ryan, although one provision that did surprise him was the total restriction on development activity. The draft code proposed 10% of a REIT be allowed for development. But again Ryan feels this restriction will be relaxed as the market matures.
"In general the SFC has listened to the industry and shown a flexible approach," he concludes. "In time as the market develops a lot of the more restrictive elements will probably be relaxed as has happened in Australia and the US. The ideal situation is for the market to dictate things such as the level of gearing."
