SA REITs: Will investors benefit?

The publication of new listing requirements that will facilitate the South African Real Estate Investment Trust (REIT) structure, will likely see most listed property companies converting to the new dispensation as a result of the tax benefits provided.

The SA REIT structure will officially be introduced on May 1 this year. Both types of listed property investment entities in South Africa – property loan stocks companies (PLSs) and property unit trusts (PUTs) – will be able to adopt a regulatory framework set out by the JSE and qualify to list on the REIT board of the JSE.

According to Estienne de Klerk, chairman of the Property Loan Stock Association’s REIT Committee and executive director of Growthpoint Properties, the REIT structure is in line with international best practice. The tax advantages of the new structure will also make the listed property sector much more attractive to foreign investors, he says.

Under the new tax dispensation, a SA REIT will be able to deduct all distributions paid to shareholders or linked unitholders as an expense. The REIT will also be exempt from Capital Gains Tax (CGT) when it sells property at a profit.

But will investors benefit?

De Klerk explains that the transaction cost for local investors will be reduced because there is no securities transfer tax payable on listed REITs any longer. Investors will also have certainty on the tax treatment within the investment vehicle as well as in their own hands, he says.

“In your own hands the distribution you received was always taxable at your marginal rate and that will remain the case, but there is a higher level of clarity of what the tax position is.”

The one negative for local investors is that for the private investor the interest exemption (currently R23,800 for individuals under 65 and R34,500 for individuals over 65) that previously applied to property loan stocks, will not be available anymore. National Treasury sees this distribution as rental income and not as interest and is currently working towards abolishing this interest exemption and looking to create specific tax-free investments.

“The inclusion in various international REIT indexes might in the short term have an impact for the positive potentially on the sector, but clearly the market prices these instruments on a forward yield,” says De Klerk.

De Klerk says his personal view is that companies won’t increase their distributions because they have converted to the REIT structure.

“Most of the companies are currently paying 100% distributable earnings to unit holders already and the only change really for them will be the fact that they don’t have to pay capital gains tax on the properties they sold, which was never a material number in the scheme of things anyway.”
Over time there might be a positive impact on the yield, but it will be marginal, he says. “It really just solidifies the good performance of distribution growth supported by rental that you have to date.”

In the case of foreign shareholders of SA REITs, a dividend withholding tax will be applicable after 1 January 2014. The current rate is 15% or the applicable double tax agreement rate could apply. This is in line with international standard tax practice.

An analyst's take

Neil Stuart-Findlay, property portfolio manager at Investec Asset Management, says on the margin the introduction of the REIT structure is positive.

In the past, property loan stocks would have to account for a deferred tax liability on their balance sheets as properties increased in value over time. This deferred tax related to the capital gains tax that would be payable upon selling those properties in due course.

The migration to the REIT status, which is likely to happen over the course of the next 18 months, will, from an investors perspective, create certainty that a tax liability or deferred tax on the balance sheet will not have to be paid, he notes.

Stuart-Findlay explains that the removal of the liability from the balance sheet will result in an increase in the net asset value of the company. On balance, the price to book value will be lower, which is a more attractive proposition for investors, he says.

“But the important thing to realise here is that the price to book measure for these companies is very much a secondary valuation methodology in the South African real estate sector. The predominant focus for investors is really on cash-flow and income so investors are predominantly looking at the yields of the various companies and the growth rates attached to that yield and cash-flow.”

“So from that perspective there won’t be any major change in terms of the distribution,” he says.
He notes however that the real implication is that it will create a more transparent vehicle in line with global best practice. In the medium to longer term this could potentially lure offshore investors who are more familiar with the REIT structure.

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