Contracting with a UK REIT - does it make a difference?

REITs hit the UK landscape in January 2007 and now many of the best known names in the UK property world are REITs - Land Securities, Hammerson, Great Portland Estates, British Land to name a few.  As a matter of course there are certain questions one always considers in terms of the party with whom you are contracting.  It is important to consider whether they are executing the documentation correctly and, indeed, their power to enter into the transaction.  If it is a foreign entity the obtaining of a legal opinion is advisable.

REITs add something different to the mix and the risk to a party contracting with a REIT is that without knowledgeable legal advice one can be exposed to unnecessary risks or, indeed, lose out on potential advantages.

The rules governing REITs are complex and affect not only the REIT itself but also those with whom it contracts.  A REIT's business is split into a Property Rental Business (PRB) (which must be at least 75% of its total income) and the remainder being its Residual Business.  PRB income is effectively tax exempt (there is 20% withholding tax which exempt investors can reclaim) whereas the income from the Residual Business is taxable at 28%.

It is beyond the scope of this blog to go into detail (nor would I wish to give away trade secrets quite so easily) on the potential issues and pitfalls that can arise when dealing with a REIT but some highlights include:

• the sale of shares in an SPV property company by a REIT will be a Residual Business which may have negative tax consequences
• the base cost of a property in an SPV once owned by a REIT may be higher or lower than the SPV paid for it
• the sale by a REIT of a development within 3 years of practical completion is likely to be a Residual Business which again has negative tax consequences
• whilst the PRB part of the REIT does not pay tax it still benefits from capital allowances to reduce the dividend payments it needs to make so REITs will not simply give these up
• Joint Ventures with REITs raise all sorts of governance and tax issues and potential advantages

As mentioned the REIT legislation also provides potential opportunities as well.  Therefore it is key that when you are getting into bed with a REIT you know what those opportunities are and how to exploit them for both parties' benefit.