USA REIT Regulatory Changes May Benefit REIT Outside USA

Stephen Chung

Managing Director

Zeppelin Real Estate Analysis Limited

March 2007

A recent legislative introduction by 4 House of Representatives in the USA on REIT would relax the regulatory environment for USA REIT in particular for ones eyeing Non-USA REIT and real estate, according to the February 23, 2007 issue of National Policy Bulletin published by the National Association of Real Estate Investment Trusts (NAREIT) of which your humble author is a member. Part of the rationale relates to increased USA investment interest in foreign (non-USA) assets and that REIT need to have more flexibility in investment decision to stay competitive. Some of the highlights are as follows: 

1)      Foreign exchange currency gains which a REIT generates from operating non-USA real estate would qualify under both REIT gross income tests i.e. 75% minimum must come from real estate related sources and that 95% minimum must be derived from rents, dividends, interest, and / or the like. Currently how these exchange currency gains are to be treated is not specifically mentioned.

 

2)      The .safe harbor・ test would change for dealer sales would change by reducing the holding period from 4 years to 2 years and the 10% sales test would be measured on a fair market value rather than on a tax basis. This safe harbor test is to differentiate (and appears to discourage) real estate assets bought for flipping (dealer activities) rather than for holding and the legislation will shorten the timeframe from 4 to 2 years. Likewise, the 10% sales test in each year should not constitute more than 10% of the REIT value, though the basis of that value measurement is proposed to be changed from a tax perspective, which actually discriminates against long-investment-holding REIT, to a market value perspective.

 

3)      The USA REIT can own stock in a foreign REIT under the same rules which apply to ownership of stock in another USA REIT, provided the foreign REIT is organized in a country with REIT tests similar to those of the USA. The current situation is that a USA REIT may lose its REIT status if it invests more than 10% in the stock of a foreign REIT, even if that foreign REIT resembles a USA REIT. Do note however a USA REIT can invest directly in foreign real estate without restriction.  

There are a few more points in the legislation yet the above appear to matter most to investing in non-USA real estate by USA REIT. Nonetheless, your humble author claims no expertise in such USA REIT legal and statutory frameworks and thus has included the NAREIT web link to related documents below for readers who wish to have more details: 

http://nareit.com/policy/government/ridea.cfm 

Being in non-USA real estate markets, your humble author and presumably many of his readers would wish to know how a foreign REIT may qualify under this proposed legislation to become qualified and proper sufficiently for investment by USA REIT without causing such USA REIT to lose their REIT status in the USA. 3 points exist and a foreign REIT would be treated as real estate for the purpose of USA REIT tests if the practices and rules of such foreign countries require:

A)      The listed foreign REIT must have a minimum of 75% of its assets invested in real estate.

 

B)      The foreign REIT either received a dividends paid deduction OR is exempted from corporate level tax.

 

C)     The foreign REIT is to distribute a minimum of 85% of its income to shareholders annually. 

It is also interesting to note that the above requirements harbor further flexibility too as .customary practices・ in the foreign places may be taken into account. For instance, a country may only require its REIT to distribute 50% of the income yet if it is customary (common) for REIT in that country to distribute 90% or more, such foreign REIT may still qualify to be treated as real estate in the USA REIT framework. 

Thus, at a glance, it appears Hong Kong-based REIT would have no problems fulfilling points A and C, yet your humble author is not entirely sure of point B and its interpretation-comprehension. Definitely, Hong Kong REIT are taxed on the corporate level thus ruling out the possibility of acceptance by USA authorities on being corporate tax exempted (the latter portion in point B). As to :a dividends paid deduction; (the former portion in point B), and assuming this to mean taxing the income only after dividends are distributed, it appears that Hong Kong REIT does not fit into this technicality either.  

In short, Hong Kong REIT MAY not qualify for investment by USA REIT else the USA REIT will lose its REIT status under USA REIT law. IF so, this would mean the Hong Kong REIT market is somewhat deprived not due to its being anything less or not on par with global standards in terms of attracting USA REIT investment interest, but for a technicality. Furthermore, IF this requirement is put there simply because USA REIT are not taxed corporately, would Hong Kong REIT be accepted IF we are to inform them (USA REIT authorities) that dividends from Hong Kong REIT are not taxed (as in the USA)? That is, a sort of trade off or equalizer = a) USA: no corporate tax on the REIT level but personal tax applies to dividends received from REIT; and b) Hong Kong: REIT taxed on corporate level but investors pay no tax on dividends received from the REIT [to the Hong Kong tax authorities].  

Naturally, comments and advice from experts are welcomed.

Notes: The article and/or content contained herein are for general reference only and are not meant to substitute for proper professional advice and/or due diligence. The author(s) and Zeppelin, including its staff, associates, consultants, executives and the like do not accept any responsibility or liability for losses, damages, claims and the like arising out of the use or reference to the content contained herein.                                

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