January 2015
Practice Groups:
Real Estate
Investment,
Development, and
Finance
Tax
Banking & Asset
Finance
Overview of UK Real Estate Structures and
Transactions
By Stuart Borrie, Paul Beausang and James Spencer
Summary
This Overview provides a general summary of the different corporate structures that may
be used to hold, and transact in, UK real estate (such as special purpose vehicles,
property unit trusts, partnerships and REITS), the key features of each structure and why
they are used by investors and developers. It also discusses joint ventures, where two or
more investors may wish to combine to acquire and/or develop property. This Overview
also discusses finance issues, tax and assembling a professional team.
Key vehicles used to hold UK real estate
Typical vehicles that are used are:
• Limited liability companies, whether located in the UK or elsewhere. Where the
vehicle is a "clean" special purpose vehicle ("SPV"), it will contain nothing except for
the property and the rent, leases and other contracts, and any registrations and
liabilities associated with that property. An SPV may be a convenient way of
parcelling up the real estate in a discrete entity with its own legal personality, and
which can enter into contracts, including to finance the property, manage the property
and/or develop it. Recourse can be contained and limited to the assets of the SPV.
The board of the SPV can exercise control and make professional appointments, such
as of an asset manager. By buying the shares in the company rather than the
property itself, a buyer may make significant savings by not having to pay Stamp Duty
Land Tax ("SDLT");
• Jersey property unit trusts ("JPUTs"). These are constituted by trustees who are
located in Jersey. Usually the trust instrument follows a well settled form as there are
hundreds of JPUTs in existence holding real estate all across the UK. The income in
the unit trusts belongs to the beneficiaries of the trust provided that the unit trust is
appropriately drafted so as to constitute a 'Baker Trust', and normally this is
recognised for the purposes of UK tax on income. For capital gains tax purposes, the
JPUT is treated as a company located in Jersey provided that it is correctly controlled
and managed in Jersey. The transfer of JPUT units is not usually subject to SDLT;
• limited partnerships, registered under the Limited Partnership Act 1907. These
protect the investing partners from liability provided they do not get involved in the
control and management of the partnership. Accordingly, a general partner (usually a
company with limited liability) takes full responsibility for the real estate and any
investment strategy and makes all decisions (eg whether to lease the property, who to
and on what terms). The general partner may be advised by an investment manager.
Sometimes limited partnerships are used in conjunction with JPUTs. Partnerships can
be more flexible than corporate vehicles because, for example, they do not have
capital maintenance rules or strict rules on dividends. Partnership interests are
usually considered to be real estate for the purposes of SDLT and accordingly the
transfer of a partnership interest is subject to SDLT as if the partnership interests were
Overview of UK Real Estate Structures and Transactions
land itself. Partnerships are tax transparent for most purposes, although not for VAT,
though some tax filings are needed.
• REITs – Real Estate Investment Trusts. Only a small number of very large UK
property investment companies have reconstituted themselves as REITs because the
qualifying conditions are stringent. REITs are not used for structuring particular
transactions in the UK real estate market; and
• PAIFs - property authorised investment funds. These are designed for use where
there is widely held ownership. PAIFs are open ended vehicles which are tax
transparent. They have stringent conditions. The UK Government has been
consulting during 2014 on the introduction of SDLT relief for the seeding of PAIFs,
and for the transfer of interests in PAIFs.
Finance
Often the entities holding the real estate are financed using a combination of
equity/shareholder loans and secured third party debt. The level of third party finance is
primarily a commercial matter and depends on the appetite of the investors for gearing.
Banks are much more restrained in their appetite for commercial real estate lending risk
than before the financial crisis and loan to value ratios are accordingly lower, although
loan pricing has become highly competitive (for the benefit of borrowers) and, outside of
traditional bank lenders, there is a wide range of other lenders able to provide funding on
higher LTVs.
The loan agreements will contain terms that can be expected in any facility, such as
interest terms, prepayment and hedging arrangements. They also typically contain
detailed provisions specific to running, operating and managing of the property and the
rent.
Any debt is likely to be secured on the property and any rent receipt account and it may
well also be secured on the shares, units or other equity. The debt arrangements may be
structured so that there is limited recourse to the ultimate beneficial owner. This is
achieved by the SPV being the borrower. The shares in the SPV may be secured but
otherwise the ultimate beneficial owner is not liable to the lender should there be a
default.
Internal debt may be attractive for tax purposes, provided that it satisfies transfer pricing
requirements (essentially arm’s length terms, including the amount of the loan).
The bank will typically conduct commercial and legal due diligence on the property, and
also on the holding structure and will ask for existing professional reports to be
addressed to it.
Key tax issues
Trading
A key tax issue on a number of these corporate - wrapped property entities is whether or
not they are involved in trading in real estate in the United Kingdom or whether there is
investment activity.
Where there is trading in the UK, all of the income from the activity (including any
increase in property value) would be subject to UK taxes on income. If the entity is a UK
tax resident or there is a permanent establishment in the UK (such as an office from
2
Overview of UK Real Estate Structures and Transactions
where the trade is carried on, or even a building site), then any trading activity will be
subject to UK tax.
Accordingly, care needs to be taken that investment activity is not inadvertently brought
into the category of being trading in the UK. If the property is development property
which is being developed for the purposes of a short-term sale, then it may well be
trading. By contrast, holding property for the purpose of receiving rent is likely to be an
investment activity.
Central management and control
Any vehicles in the structure which are registered offshore should be centrally managed
and controlled offshore. If in practice they are centrally managed and controlled in the
UK, then they will be treated as if they are based in the UK for tax purposes (ie they will
be liable for UK income and capital gains charges). Accordingly, care needs to be taken
that the structure is robust and that decisions which are meant to be taken offshore are
indeed taken offshore. There is usually care taken that the board has appropriate
expertise, that board meetings are properly quorate offshore and that decisions are made
at those board meetings.
Non-resident landlords
If the property owner is not UK resident, it will need to register with the UK tax authority in
order to receive rent free of any withholding under the "non-resident landlords scheme".
Joint ventures
Pooling capital and risk
Where UK real estate is particularly valuable, it may be owned by more than one party.
A joint venture or 'club deal' allows investors to contribute capital and share risk. It may
be that one party has the investment proposition and relationships and only some of the
required funding. The parties may therefore want a structure which sets out an agreed
strategy and allows investors to have rights of control or influence depending on the
relative sizes of their investments. One of the parties may also be a professional real
estate entity, providing services.
Board and shareholder control
Where there is a joint venture, typically there will be an agreement regulating
governance. Where the relevant entity is a company, as background there will be rules
relating to that company under the relevant corporate law. For example, certain matters
will require an ordinary resolution and others, being more fundamental constitutional
matters (such as an increase in capital or a change of the constitution), may require a
special resolution under the relevant company legislation. In common law jurisdictions,
those rules are often a milder variation on English company law. When the joint venture
entity is a unit trust or partnership, there may not be a clear legislative underpinning for
governance issues. In any case, the parties will specify that certain commercial matters
need a certain level of approval between the investors. There are two main ways in
which this is handled in the joint venture agreement, being 'positive' and 'negative'
matters.
3
Overview of UK Real Estate Structures and Transactions
Positive matters – business plan
Positive matters are actions that parties agree to take and they are usually set out in a
business plan with an attached budget. These set out, positively, what the parties intend
to do with the property. They form an agreed strategy, with tactics as to how to make
profits and gains from the property. The initial business plan is a very important
document and it is advisable that it is prepared before the relevant transaction is
completed.
Usually joint ventures involve an agreed business plan which is renewed every 12
months. The business plan may set out proposals for refurbishing or redeveloping some
or all of the property and a strategy for letting and sale. The business plan will be
accompanied by a budget for capital expenditure, VAT, refurbishment costs, insurance
and rent etc.
Negative matters – veto rights
'Negative' matters are things that cannot be done without consent. Accordingly a
significant deviation from the business plan should be something which any joint venture
investor should be able to veto. Matters which are minor variances from the business
plan (eg a 5% alteration in capital expenditure for any one year) are not usually open to
veto by one investor out of several.
The joint venture agreement will therefore be prescriptive and set out categories of
decision that may be vetoed (with tolerances e.g. for expenditure and voting thresholds
for different types of decision).
Exit rights
Exit rights in a joint venture typically include concepts also seen in private equity
transactions, such as:
• a right of first refusal (ie if an investor wishes to sell its stake, before selling it on the
open market, it needs to offer the stake to the other investors)
• a right of any one investor to demand the sale of the property after a period of time
• 'drag along' rights i.e. investors holding a significant majority of the investment may be
able to force the minority to sell alongside them so as to achieve the highest price
(which is usually payable on the sale of the whole)
• 'tag along' rights. When drag along rights are involved, the minority may have a
corresponding right to demand that its investment be sold whenever the dominant
owners sell. For example, if investors holding two-thirds of the equity decide to sell to
a third party, the one-third owner may have the right that its investment be sold at the
same time. After all, the investor holding one-third may not be content to be left as a
joint venture investor with a new, unknown third party.
Key features of sale agreements
Sale and purchase agreements are used to buy and sell the equity in the vehicle or
structure holding the UK real estate. The key features of the agreement are likely to be:
• the valuation is asset-based (being itself closely linked to the future yield from the real
estate, either from rent or from capital appreciation or development potential);
• they do not incorporate the Standard Commercial Property Conditions;
4
Overview of UK Real Estate Structures and Transactions
• if exchange is to be prior to completion (rather than simultaneous with completion):
o
the seller will expect the payment of a deposit (often 5%) to be held by the seller’s
solicitor as stakeholder;
o
the buyer may wish to include provisions restricting the seller’s management of
the property up to completion (e.g. restrictions on granting consents, settling rent
reviews and granting leases without consent of the purchaser);
• the agreement may include completion accounts (so there is a fair reconciliation
between the parties, which may carry on after completion) providing for the
apportionment of the benefit of rent and expenses such as VAT. Service charges
may be subject to a separate reconciliation process;
• warranties and indemnities.
Warranties and indemnities
In any corporate purchase the seller is usually expected to provide warranties and
indemnities about what it is selling (except where the seller is an administrator or
liquidator). This contrasts with a property purchase, where the buyer’s protections are
through appropriate searches, pre-contract enquiries and due diligence reports or
certificates on title.
There will also be a disclosure letter (in which the seller makes disclosures against the
warranties it is giving in the sale and purchase agreement). However:
• the property warranties are unlikely to be extensive: the seller will expect the buyer to
carry out due diligence in respect of the title to the property in the usual way;
• the seller is likely to provide replies to CPSE and other property enquiries. The buyer's
ability to sue for misleading replies to the property enquiries must be preserved in the
sale and purchase agreement. The buyer should seek a warranty that the replies to
enquiries are accurate;
• the buyer may seek a warranty that the seller has provided all necessary information
and that such information is accurate;
• tax protections about the running of the company are usually a feature of these
transactions and often there is a tax indemnity;
• where commercial problems are identified in due diligence (such as a defect in the
building), the buyer may expect an indemnity for the relevant matter.
There needs to be a blend of protections from a corporate perspective about the equity
and the liabilities of the company and the protections that the buyer would have if it
acquired the property directly.
Insurance
It is fairly common for the buyer to purchase insurance against warranty exposures and it
is a growing feature of the market. Premiums are generally around 0.5% to 1% of the
maximum exposure on the warranties. Paying premiums can allow the seller to release
capital for other purposes, as otherwise the capital would be tied up for a period of time
against the potential for a warranty claim against the seller.
5
Overview of UK Real Estate Structures and Transactions
Assembling a legal team
Generally
Buyers, sellers and other parties involved in corporate real estate transactions need to
obtain specific legal advice. Corporate real estate transactions (which may sometimes
be called "indirect property transactions") typically involve a team of people with
complementary skills and may involve law firms in several international jurisdictions
acting for each side of the transaction.
The skills relevant to making an asset acquisition are also relevant when buying a
property wrapped up in a corporate vehicle. For example, it will still be necessary in
many cases to investigate the title, conduct searches, produce a report on title or a
certificate on title, consider environmental and planning issues, assign any benefit of
existing construction warranties and deal with the requirements of lending banks wishing
to take security.
The purchase of the relevant legal entity may mean that a corporate lawyer is involved
who will ensure, for example, that the right level of warranties is provided and disclosure
against the warranties is appropriate. The purchase agreement needs to be negotiated,
completion accounts dealt with and so on.
Where the transaction involves the purchase of units in a JPUT or the establishment of a
new partnership, tax lawyers will also be involved.
Typically corporate real estate acquisitions involve a lot of documents. There may be
quite a complicated structure to set up with investment advisors agreements and
secretarial agreements. Board meetings and relevant resolutions will be required. There
may be several vehicles. Filings may be required in the UK or abroad. It is partly for this
reason, and the increased deal risk that results, that sellers may expect to share half of
any SDLT saving.
Where a JPUT is involved, increasingly the trustees will require that they have the benefit
of their own legal advice (ie separate legal advice from the advice for the unitholders).
The trustees may seek to ensure that they have recourse to the fund in the event of a
claim coming out of the transaction.
Joint ventures
Where the transaction is a joint venture, each investor will want to have the benefit of
specific legal advice and a duty of care which has regard to the transaction and the
circumstances. It is likely to be problematic under professional rules for one law firm to
act for all of the joint venture investors.
It is quite common for a key role to be taken by an investment manager appointed by the
joint venture vehicle to manage the property: there will be points in the investment
management agreement where the owner and the investment manager may have
diverging interests.
6
Overview of UK Real Estate Structures and Transactions
This article does not constitute legal advice on any particular situation. If you have any
questions, please contact us.
Authors:
Stuart Borrie, Corporate
Paul Beausang, Tax
James Spencer, Finance
Partner
stuart.borrie@klgates.com
020 7360 8155
Partner
paul.beausang@klgates.com
020 7360 8100
Special Counsel
james.spencer@klgates.com
020 7360 8176
Anchorage Austin Beijing Berlin Boston Brisbane Brussels Charleston Charlotte Chicago Dallas Doha Dubai Fort Worth Frankfurt
Harrisburg Hong Kong Houston London Los Angeles Melbourne Miami Milan Moscow Newark New York Orange County Palo Alto
Paris Perth Pittsburgh Portland Raleigh Research Triangle Park San Francisco São Paulo Seattle Seoul Shanghai Singapore
Spokane Sydney Taipei Tokyo Warsaw Washington, D.C. Wilmington
K&L Gates comprises more than 2,000 lawyers globally who practice in fully integrated offices located on five
continents. The firm represents leading multinational corporations, growth and middle-market companies,
capital markets participants and entrepreneurs in every major industry group as well as public sector entities,
educational institutions, philanthropic organizations and individuals. For more information about K&L Gates or
its locations, practices and registrations, visit www.klgates.com.
This publication is for informational purposes and does not contain or convey legal advice. The information herein should not be used or relied upon
in regard to any particular facts or circumstances without first consulting a lawyer.
© 2015 K&L Gates LLP. All Rights Reserved.
7