International Bar Association Conference
Real Estate Investment Trusts
Panel 3 - REIT Operating Considerations
17 October 2007
Singapore
REIT Operating Considerations - Panellists
 Jerry Koh, Partner, Allen & Gledhill LLP (Chair)
 Michael Blair, Partner, Mayer Brown LLP
 Blair Cowper-Smith, Partner, McCarthy Tétrault LLP
 Pieter de Ridder, Partner, Loyens & Loeff
 Scott Newman, Partner, K&L Gates
 John Sullivan, Partner, Mallesons Stephen Jaques
 Yap Chee Meng, Partner, KPMG
1
Discussion topics
 Tax treatment
 Investment restrictions
 Financing
 Financial engineering
 Accounting
 Governance framework
2
Tax treatment
Panellists: Pieter de Ridder & Scott Newman
 How is the income derived, and the distribution made, by a REIT
taxed in the different jurisdictions, in terms of withholding taxes,
dividend/distribution taxes or any taxes payable by the recipients?
 Are there any jurisdictions which are particularly attractive from a
cross-border perspective in Asia or other parts of the world?
3
Tax treatment - General
 Tax position of dividend and rental income earned by the REIT
 Are expenses incurred by the REIT tax deductible
 Gains derived from the sale of assets taxable or non-taxable
 Stamp duty/transfer taxes on the acquisition and sale of property
or shares
 Withholding tax suffered on overseas income earned by the REIT:
cost of business or can it be credited
 Withholding tax on distributions made by the REIT
4
Tax treatment – United States
 At least 95% of REIT’s gross income must be derived from:




Dividends



Abatements and refunds of taxes on real property
Interest
Rents from real property
Gain from the sale or other disposition of stock, securities and real
property (including interests in real property and interests in
mortgages on real property) which is not “dealer” property
Income and gain from foreclosure property
Amounts (other than amounts the determination of which depends
in whole or in part on the income or profits of any person) received
or accrued as consideration for entering into agreements (i) to make
loans secured by mortgages on real property or (ii) to purchase or
lease real property (including interests in real property and interests
in mortgages on real property)
5
Tax treatment – United States
 At least 75% of the REIT’s gross income is derived from:



Rents from real property

Dividends or other distributions on, and gain from the sale or other
disposition of transferable shares (or transferable certificates of
beneficial interest) in other REITs


Abatements and refunds of taxes on real property
Interests on obligations secured by mortgages on real property
Gain from the sale or other disposition of real property (including
interests in real property and interests in mortgages on real
property) which is not “dealer” property
Income and gain from foreclosure property
6
Tax treatment – United States
 At least 75% of the REIT’s gross income is derived from (cont’d):

Amounts (other than amounts the determination of which depends
in whole or in part on the income or profits of any person) received
or accrued as consideration for entering into agreements (i) to make
loans secured by mortgages on real property or on interests in real
property; or (ii) to purchase or lease real property (including
interests in real property and interests in mortgages on real
property)

Qualified temporary investment income
7
Tax treatment – United States
 At the close of each quarter of the taxable year
A.
At least 75% of the value of the REIT’s total assets is represented
by real estate assets, cash and cash items (including receivables)
and Government securities; and
B.
(i) Not more than 25% of the value of the REIT’s total assets is
represented by securities (other than those includible under
(A) above);
(ii) Not more than 20% of the value of the REIT’s total assets is
represented by securities of one or more taxable REIT
subsidiaries; and
8
Tax treatment – United States
 At the close of each quarter of the taxable year (cont’d)
B.
(iii) Except with respect to a taxable REIT subsidiary and
securities includible under (A) above:
(I)
Not more than 5% of the value of its total assets is
represented by securities of any one issuer;
(II) The REIT does not hold securities possessing more than
10% of the total voting power of the outstanding
securities of any one issuer; and
(III) The REIT does not hold securities having a value of
more than 10% of the total value of the outstanding
securities of any one issuer
9
Tax treatment – United States
 The REIT must distribute at least 90% of its real estate
investment trust taxable income (as defined) for the taxable
year
 Ability of REIT to designate dividends as long-term capital
gains dividends
 Many REITs distribute far more than their real estate
investment trust taxable income, with the result that much of
their dividends may very well constitute return of capital
distributions
10
Tax treatment – United States
 REITs can engage in hedging transactions to the extent that such
transactions hedge any indebtedness incurred (or to be incurred)
by the trust to acquire or carry real estate assets, provided such
transactions are clearly identified as such on or before the close
of the day on which it was acquired, originated or entered into.
Thus, hedging gains generally do not enter into the determination
as to whether the REIT satisfies the 95% and 75% gross income
tests
11
Tax treatment – United States
 Taxable REIT subsidiaries can be used to perform activities that
cannot be conducted by the REIT itself (e.g., the provision of
“impermissible tenant services”). However, corporations that
directly or indirectly operate or manage lodging or health care
facilities, or provide any person rights to any brand name under
which such facility is operated, cannot be taxable REIT
subsidiaries. Certain exceptions to the foregoing rule apply,
however, where a lodging facility is operated by an independent
contractor
12
Tax treatment – United States
 No limit on the ability of a REIT to invest in foreign real estate
 However, it is unclear whether exchange gains constitute
qualifying income for purposes of the 95% and 75% gross
income tests
 REITs generally will not be able to claim a foreign tax credit for
foreign income taxes incurred, nor can they pass-through foreign
tax credits to their shareholders
13
Tax treatment – United States
 Dividend distributions by a US REIT to foreign shareholders are
generally subject to a 30% US withholding tax unless an
applicable treaty applies
 Under the existing US-Canada Income Tax Treaty, the US
withholding tax on dividend distributions from a US REIT are
reduced to 15% where such dividends are beneficially owned by
an individual holding an interest of less than 10% in the trust; in
all other cases, the withholding rates otherwise applicable under
US law apply
14
Tax treatment – United States
 Under the Protocol to the US-Canada Income Tax Treaty, signed
on September 21, 2007, the 15% US withholding rate will apply if:
 the beneficial owner of the dividends is an individual holding an
interest of not more than 10% in the REIT;
 the dividends are paid with respect to a class of stock that is publicly
traded and the beneficial owner of the dividends is a person holding
an interest of not more than 5% in any class of the REIT’s stock; or
 the beneficial owner of the dividends is a person holding an interest
of not more than 10% in the REIT and the REIT is diversified
 A foreign person is not subject to US income tax (including
withholding taxes imposed under Internal Revenue Code section
1445) on the sale of the stock of a US REIT if such stock is
regularly traded on an established securities market and such
person has not generally held at any time more than 5% of the
class of such stock
15
Investment restrictions
Panellists: Blair Cowper-Smith, Scott Newman & John Sullivan

Why do REITs need to have investment restrictions and what are
common examples of these?

What is the approach towards development and joint ownership
of assets?
16
Investment restrictions – Asia Pacific
Regulatory Requirements
Hong Kong
Singapore
Australia



Generally
50% +


Investment in property
development allowed

(10%)

(10% including
development activities
within REIT)

(For properties
to be held by
REIT)
Development activities
allowed within REIT

For properties to be
held by REIT
Within stapled
vehicle
Overseas investment
allowed
Partial ownership of
properties
(10% including
investment in property
development
Investment outside real
estate allowed


(Subject to 25% cap)

17
Investment restrictions – North America and Europe
Regulatory Requirements
US
Canada*


(25% Asset Test)
No restrictions, but subject
to 75% Asset Test and
25% Asset Test

(No restrictions if investment
otherwise permitted)
Investment in property
development allowed

(Subject to 75% Income
Test and 95% Income
Test)

(Cannot “trade” in properties
and subject to Declaration of
Trust)
Development activities
allowed within REIT

(Subject to Asset and
Income Tests)
Investment in raw land
usually limited to 15% of
gross book value
Investment outside real
estate allowed
No limits, subject to Asset
and Income Tests

(May invest in mortgages)
Overseas investment
allowed
Partial ownership of
properties
*Cannot hold hotels or retirement
homes due to impurity of income
stream
18
Investment restrictions – Canada
 REIT must qualify as a “mutual fund
trust” (“MFT”)
 MFT status depends on being widely
held and activity of the REIT being
limited to holding or managing real
property that is capital property of the
REIT
 Trust-on-trust structures and similar
arrangements
Public REIT (“MFT”)
must be passive
Distributions or
interest
Real estate
investments held in
Sub’s or
partnerships that are
not MFTs
19
Investment restrictions – Canada
 2007 new distribution tax introduced on income trusts
 Safe harbour for REITs:

REIT must not hold non-portfolio property (shares or ownership
interests in other entities that exceed certain value thresholds)
other than “qualified REIT properties” which essentially means real
property that is capital property



At least 95% of its income must be from property
75% of its income must be from real property in Canada
75% of its assets consists of real estate situated in Canada
20
Investment restrictions - Trends
 Cross-border REITs
•
•
Most jurisdictions now allow overseas investment
A strong trend driven by stable capital markets and scarcity of local
property (e.g. Singapore, Australia)
 Development and internalised management
•
•
•
•
Attitudes to development exposure vary between jurisdictions
Move to internalised management in more mature markets
Stapled structures – investors own the manager/developer
Risk/return increase by including operating business
 Broader asset classes
•
•
Hotels, retirement villages, leisure etc
Toll roads, tunnels and other infrastructure
21
Financing
Panellists: Michael Blair, Blair Cowper-Smith & John Sullivan

What are the common ways to raise finance in the various
jurisdictions - equity, debt (secured/CMBS, unsecured,
convertibles/exchangeables), hybrids, derivatives?

Are there any gearing or leverage limits imposed by the
regulators?
22
Financing – United States
 No statutory or regulatory limits on leverage
 Limits may be imposed by indentures, lenders and credit rating
agencies
 Common REIT capital raising:
 Common Stock
 Preferred Stock (perpetual or convertible)
 Debt Securities (senior unsecured, CMBS, mortgage or convertible)
 Private Funds
 REITs typically maintain standard bank operating lines to support
operating and related cash flow needs (paid down with public debt
issuances)
23
Financing - Canada
 Declaration of Trust generally includes loan to value limits
 REIT credit ratings are generally not sufficient to support
unsecured debentures
 REITs not permitted to finance by way of preferred equity
 REITs typically maintain standard bank operating lines
 Long-term debt needs - convertible debentures
 Recent amendments to the Canada/US Tax Treaty will reduce the
cost of capital further with the elimination of withholding tax
24
Financing - Australia
 Typical REIT funding sources – choice varies with market
conditions




Further equity (e.g. rights issue or placement)
Wholesale fund spin-off
Bank and other debt
Convertibles/hybrid securities
 Hybrid securities popular for REITs




Usually an attached funding vehicle

Driven by lower cost of capital and ability to tap different investor
base
Usually listed either on ASX or more recently Singapore
Often convertible/exchangeable into REIT equity
Often equity for accounting and bank covenants but with debt-like
features
25
Financing – Leverage limits
Jurisdictions
Leverage limits
Hong Kong
45%
Singapore
35% (60% if rated)
Australia
Unrestricted
US
None
Canada
60% generally
26
Financial engineering
Panellist: Yap Chee Meng
 When does financial engineering cross the line and make
investors and regulators uncomfortable?
27
Financial engineering
 Market conditions may encourage use of financial engineering,
e.g. to boost distribution yields
 A variety of methods used in different jurisdictions, many
essentially involving return of capital to investors as part of
distributions
 Examples:






Step-up interest rate swaps, fees and interest rates on borrowings
Hedging/borrowing arbitrage for cross-border REITs
Management fee waivers, or fees paid in units
Income support in relation to properties
Deferred payment for acquisition
Borrowing to pay distributions (distribution in excess of cashflow
from operations)
28
Financial engineering
 Generally, regulators will allow a level of engineering with clear
disclosure. Similarly, investors will accept some, but overengineering has led to capital strikes (e.g. Hong Kong step-up
swaps)
29
Accounting
Panellist: Yap Chee Meng
 What are the common accounting issues experienced by a REIT?
E.g. investment property classification/cash trap, deferred tax,
marking to market financial instruments etc.
30
Accounting
 Cash trap arising from differences in accounting standards on
cross-border REITs
 Deferred taxation on revaluation of investment property
 Income support – revenue or adjustment to purchase price?
 Acquisition of property holding company - acquisition of asset or
acquisition of business?
 Revenue recognition – straight-lining of step-up rental income,
lease incentives e.g. rent-free
 Consolidation - should a REIT Manager consolidate the REIT?
31
Governance framework
Panellist: Blair Cowper-Smith
 Do REITs really provide an enhanced governance framework?
 What are the pros and cons of the trust/trustee vs company
models, external vs internal management models?
32
Governance framework - General
 Governance framework for REITs quite different than for
corporations
 REITs may lack statutory protections:
 Dissent rights in re-organization transactions may be lacking
 Oppression remedy may be absent
 Unitholder proposals may not be possible
 Derivative actions not necessarily available
 Creditor rights
 Two tier structure a challenge in relation to governance
33
Governance framework - General
 UPREIT Structure
100%
Public
REIT
Limited
Partners
Operating
Partnership
Assets
34
Governance framework - General
 Fiduciary duties for trustees may be somewhat different than as
prescribed by corporate law
 Risk of unitholder trust liability has resulted in the introduction of
protective unitholder legislation
 Many REITs are managed externally - spin-off history
 Separating management from the REIT permits isolation of
management related costs and limits the possibility of unwarranted
internal overhead growth but valuation discounts may apply
35
Governance framework – United States
 US REITs – Maryland statute


Many US REITs organized in Maryland
Corporate or Trust REITs
 Corporations have well-defined statute and that may not be altered in
certain cases:
 Standard of conduct for directors; standards for dividends;
stockholder approval for charter amendments; procedures for
voluntary dissolution; appraisal rights; record dates
 Trust REITs have more general statute and offer greater flexibility
 Must be dealt with in the declaration of trust or bylaws
 Shareholders appraisal rights in mergers may not be modified
36
International Bar Association Conference
Real Estate Investment Trusts
Panel 3 - REIT Operations
17 October 2007
Singapore