UK real estate insights Issue 16 – April 2010 02 The state of the market 06 UK economy 08 Financial services sector 10 UK hotels forecast 12 How did the budget affect real estate? 15 Government consultation: Investment in the Private Rented Sector 16 Changing investor demands: Can you demonstrate that your operating model is fit for purpose? 20 Regulation for the real estate Industry – Alternative Investment Fund Manager Directive 24 Real estate and the UK offshore funds rules 26 Tenant administration: The least attractive option of several evils 30 Emerging Trends in Real Estate Europe 32 Financial reporting update 33 Going Global Print Quit Contents
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UK real estate insightsIssue 16 – April 2010
02 The state of the market
06 UK economy
08 Financial services sector
10 UK hotels forecast
12 How did the budget affect real estate?
15 Government consultation: Investment in thePrivate Rented Sector
16 Changing investor demands: Can youdemonstrate that your operating modelis fit for purpose?
20 Regulation for the real estate Industry –Alternative Investment Fund ManagerDirective
24 Real estate and the UK offshore funds rules
26 Tenant administration: The least attractiveoption of several evils
30 Emerging Trends in Real Estate Europe
32 Financial reporting update
33 Going Global
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The state of the marketWelcome to the latest editionof our quarterly UK real estateinsights newsletter.
The first quarter of the year providesmany opportunities to gauge sentimentin the market, culminating in the realestate industry’s annual jamboree atMIPIM. Before that, in February, we hadthe launch of our annual EmergingTrends in Real Estate Europe surveythat we publish with the Urban LandInstitute. More details on the report areincluded in this edition of UKREI, but itwas clear from the survey, the paneldiscussions at the launch events acrossEurope and from MIPIM that there aresome common themes. Since lastsummer, we and other commentatorshave noted the return of cautiousoptimism to the real estate industry.As noted in Emerging Trends, thiscautious optimism was tempered bytwo major concerns, the state of theeconomy and the significant volumeof bank balance sheet and CMBSrefinancing maturing in the next fewyears.
A year ago in UK real estate insights, asthe first signs of a recovery in real estatecapital markets were emerging, wecommented on the fragility of theoccupier market and the dangers ofongoing economic recession. During thesix quarters of contraction (whichextended from the second quarter of2008 to the third quarter of 2009) theeconomy shrank by over 6%. Our latesteconomic update, which includespositive short-term news, is included
later in this edition of UK real estateinsights. The improving economicsituation is helping to reduce the numberof business failures. The latest PwCanalysis into corporate insolvencynumbers that were published last weekdemonstrate that the effect of thedownturn on UK business is showingmore signs of easing. 4,251 companiesbecame insolvent in the first threemonths of 2010. This represents a 4%decrease on the previous quarter and asignificant 20% decrease in comparisonto the same quarter of 2009. However,
on a rolling twelve month basis, thenumbers still show a 5% increase ininsolvencies. The worst affected sectorscontinue to include Construction (674companies), Manufacturing (620), Retail(456) and Real Estate (141), but therehas been a marked improvement acrossall these sectors. Compared to the samequarter of 2009, Construction has seen adecrease in insolvencies of 17%, 14% inManufacturing, a big decrease of 33% inretail and a 16% decrease in Real Estate.
The state of the marketDespite the improving situation,particularly in retail, we expect there tobe continuing occupier failures. The wayin which those failures are handled hasbeen a major bone of contention for thereal estate industry. The use of pre-packadministrations and Company VoluntaryArrangements has been the source ofcomment in the trade press. Very littleattention has been paid to a third option,Schemes of Arrangement. Elsewhere inthis edition of UKREI, we take a brieflook at all three options.
In the medium term there are significanteconomic concerns as the country isweaned off quantative easing and theimpact is felt of steps to reign in theburgeoning budget deficit. However,although the UK has an annual budgetdeficit close to Greek levels, there areother countries that are in a worseposition. Our macro-economic team hasrecently ranked 18 countries, firstlybased on weighting and scoring ofcountries against key indicators andsecondly an assessment of the degree offiscal tightening required up to 2020 to
achieve a sustainable long-term debt toGDP ratio. The first approach providesonly a relative country ranking, while thesecond also gives an indication of theabsolute scale of the fiscal sustainabilityproblem in different countries. The broadranking of countries using these twoapproaches turns out to be relativelysimilar. Greece and Ireland consistentlyappear at the top of the fiscalvulnerability rankings, followed in varyingorders by Spain, Portugal, Japan and theUS. The UK ranks 9th under the firstmeasure and 7th under the second.When my colleague John Hawksworthpublished the analysis in March, hecommented, “While the fiscal challengesfacing the UK are not as great as thosefacing countries such as Greece, Ireland,Spain or Portugal, the scale of the fiscaladjustment required in the UK isnonetheless large in absolute terms.Once the fiscal costs of ageing are takeninto account, we estimate that a fiscaltightening building up gradually toaround 11% of GDP per annum in 2020would be needed to put us on track tohit a 40% of GDP net debt to GDP targetin 2050. This compares to the fiscaltightening of around 6% of GDP by2017/18 already planned by the currentUK government, which does not takeaccount of these fiscal costs of ageingand is based on relatively optimisticmedium-term economic growthprojections”.
In terms of what this means, we haverecently published a report, “Seizing theday: The impact of the global financialcrisis on cities and local publicservices”. The report, based oninterviews with local government leadersin 22 countries, outlines the challengesand opportunities facing local leadersfollowing the onset of the global financialcrisis, and sets out views on the futurefor cities and local governments. Withthe private sector set to continue theslow climb out of recession over the next12 to 18 months, the trouble is only justbeginning for the public sector. Thesurvey revealed:
• Just over two thirds (67%) believe thatthe global financial crisis has had asignificant impact on theirorganisations.
• Almost two thirds (63%) have alreadyseen a revenue shortfall of up to 20%,13% a shortfall of 20% to 40%, and aremarkable one in 20 (5%) is seeingan impact of more than 40%.
• More than half (55%) believe there hasbeen a slight or highly adverse impactof the crisis on their city’s/localgovernment’s image.
In respect of the UK property market,and London in particular, there was a
The state of the marketconcern in both the Emerging Trendsreport and the subsequent paneldiscussion that the pricing of primeproperty did not reflect the fragility of theunderlying fundamentals. The latest IPDfigures for to 31st March show anotherquarter of growth. There is furtherpositive news for London. As discussedelsewhere in this edition of UK realestate insights, there are signs ofrecovery in the financial services sector.Over a year ago, we commented thatone of the drivers for recovery in Londonwould be a recovery in Initial PublicOfferings (IPOs). The London StockExchange regained its number oneposition for IPOs among European stockmarkets in the first quarter of 2010.This helped Europe as a wholeoutperform the US exchanges by bothnumber and value of IPOs during theJanuary to March period, according tothe latest IPO Watch Europe, thePricewaterhouseCoopers survey trackingthe volume and value of IPOs aroundEurope. London led Europe in bothvolume and value with 20 IPOs raising€2,092m in the quarter, up from 14 IPOsthat raised €951m in the previousquarter.
In March we also published the thirdannual edition of “Cities of opportunity”,a joint project between PwC and thePartnership for New York City. The studyis a quantitative and qualitative analysisof 21 capitals of business, finance and
culture worldwide to determine whichcity policies are working best forbusinesses and citizens. London rankedfirst for economic clout.
Real estate fund managers have alsohad a very challenging two years.In this issue of UKREI, we look at threechanges that are likely to add to theburden. Firstly there is the changingattitude of investors to risk,transparency and governance.Secondly there is the changingregulatory environment with the EU’s
looming introduction of the AlternativeInvestment Fund Manager Directive.Finally UK fund managers also faceadditional tax complexities fromchanges to the offshore fund rules.
At our annual UK real estate clientconference last May, I commented thatas a real estate team, we were extremelyproud of the fact that we had been at theepicentre of the real estate crisis duringthe previous year, in our role on theadministration of Lehman and throughour work advising the UK Treasury on
the Asset Protection Scheme. Theseroles have continued since then, andPwC issued its latest six monthlyupdate to creditors on Lehman on14th April. PwC UK is now also providingseconded specialist staff to NAMAduring the set up of the Agency. At theconference, I also mentioned ourappointment as Administrator ofCastlemoor, at that time the largestcommercial property developer inadministration and Oakdene, at that timethe largest residential property developerin administration. We continue to winappointments to advise banks andborrowers. Our debt advisory practiceled by my colleague Simon Boadle hasbeen advising a number of borrowers onrestructurings of their capital structureand renegotiations with their lenders.We also continue to advise many of thebanks and have had a busy quarter inthis area too, including formal insolvencyappointments.
In March, partners ofPricewaterhouseCoopers LLP wereappointed as administrators for twosignificant property ventures. Ian Green,Rob Hunt and Ed Macnamara wereappointed joint administrators toSwayfields Limited and Swayfields ExtraMSA Holdings Limited on Friday 5 March2010. Swayfield Group, headquartered in
The state of the marketLincoln with an annual turnover ofapproximately £13 million, operates11 roadside service areas (six motorwayservice areas, two trunk-road serviceareas and three forecourts) acrossEngland. The individual sites are notsubject to any insolvency process andare continuing to trade as normal.Mark Batten, Matthew Hammond andPeter Spratt were appointed jointadministrators of BirminghamDevelopment Company Limited (“BDC”)and Build Ability Limited on 26 March2010. BDC’s principal asset is The Cubedevelopment, an iconic mixed-usebuilding designed by Make Architectsincluding residential, office, retail,restaurant and hotel space, inBirmingham.
At our UK real estate conference lastyear, I also mentioned that since 2007,we have been working with the CoreCities Group – the eight largest EnglishCities outside of London – to help themidentify how they could increaseinfrastructure investment and inconjunction with them we published areport calling for new approaches and inparticular proposing a new conceptcalled Accelerated Development Zonesor "ADZs". These are based on US taxincrement financing (TIF) models,and we have continued to lobby for theintroduction of this form of TIF in the UK.Other organisations, particularly theBritish Property Federation have also
been actively lobbying for theintroduction of TIFs. We are obviouslypleased that the 2010 Budget made£120 million available to pilot ADZs inEngland. At the moment there is a lackof detail available on the pilotimplementation process, but we willcontinue to update you on progress asthere is more to report.
Something else that we are very proud ofthat has been attracting media attentionin recent weeks is our new officebuilding that is being built at MoreLondon Bridge. The 48,000m2 officebuilding ‘raises the bar’ for sustainableoffice design. It is the first building in thecapital, and the first major office in theUK to be awarded the BREEAM‘Outstanding’ rating. The building’s shellis now complete, and is currently beingfitted out internally. It is due for fulloccupation in early 2011. The building isgenerating a lot of interest in theindustry, so we will be providing moreinformation during our annual UK realestate client conference in June and theJuly edition of UK real estate insights.
And finally, a number of commentatorsblogged that this year’s MIPIM was asober affair, clearly overlooking the partyat the Irish Pub by the harbour on StPatrick’s night, the suit worn by TomBloxham’s of Urban Splash – evenRupert Bear only wore the trousers andnot the jacket too and the large quantity
of brightly coloured lycra in evidence onthe Tuesday afternoon, in which I wasvery pleased to have played a part. MyMIPIM started earlier than for many, as Itook part in this year’s Cycle2Cannesevent. 85 of us cycled the 1,500KM fromLondon to Cannes raising money for avariety of charities. I would particularlydraw attention to two real estate industryrelated charities that are significantbeneficiaries. LandAid is already well-known in the UK real estate industry andhas a specific focus on helping theyoung and disadvantaged. Article 25 isless well known. It is a UK registeredcharity that designs and deliversbuildings and structures for those ingreatest need worldwide. The namerefers to the 25th Article of the UniversalDeclaration of Human Rights, which isthe only article which refers to the builtenvironment. It says that adequateshelter and housing are a fundamentalhuman right. One of their key projects atthe moment is post-earthquake schoolreconstruction in Haiti. Cycle2Cannes ispossibly the best organised cyclingevent in which I have participated induring my nearly 30 years’ of cycling andis immensely good fun. Anyone who iseven vaguely thinking of this shouldcheck out the Cycle2Cannes.org.uk.Nick, I can only say “chapeau!” Thanksalso to Jeremy Helsby for allowing 85hideously sweaty, lycra-clad cyclists topile into the Savills café by the Palais at
the end of the ride, drink their beer andclean them out of a week’s supply ofcanapés in two hours. I suspect that thestand had to be fumigated before Savill’smore prestigious clients were invitedback in! May I also thank AngusHenderson from F&C REIT, my room-mate for the ride. We accepted eachothers’ rapidly declining personalstandards and I can only apologise formy catastrophic accident with therecovery drink shaker in the bathroom onthe final evening – I am sure that thecleaning staff the next morning realisedat once that it was chocolate milkshakeon the floor, walls, ceiling and mirror.The Cycle2Cannes website includesdetails of how you can still sponsor ourcollective effort.
We are always keen to hear your viewson the topics covered in this and otherreal estate publications and at ourvarious seminars and conferences.We appreciate suggestions as to areasthat we should cover in the future, soplease share your thoughts with theteam. We are particularly interested inyour thoughts for topics for futureeditions of UK real estate insights andfor our UK real estate client conferenceon 17th June.
John ForbesReal Estate Industry LeaderEurope, Middle-East and AfricaPricewaterhouseCoopers LLP
UK economyAs discussed in the introductionto this edition of UK real estateinsights, the state of the economyand the impact that this will haveon the occupier market remains akey concern for the real estateindustry. Our latest UK economicoutlook was published in March.Since then we have had theannual UK Budget and thepublication of some positivestatistics.
UK GDP grew by an estimated 0.4% inQ4 2009, with the year-on-year rate ofcontraction easing to 3.1%. The Q4 dataconfirmed that the UK has emerged outof its deepest recession since quarterlyrecords began in 1955. During the sixquarters of contraction (which extendedfrom the second quarter of 2008 to thethird quarter of 2009) the economyshrank by over 6%.
The Chartered Institute of Purchasingand Supply (CIPS)/Markit ManufacturingPMI index, like its services counterpart,was on an upward trend during 2009.Since the start of 2010, both indiceshave continued to remain above the 50mark, which points to economic growth.The services index recorded itseleventh consecutive month above50 in March 2010.
House price indices have continuedto strengthen, with both the Halifax andNationwide indices recording increasesin the final month of 2009 and into 2010.However, these figures must be viewedwith caution as the apparent recentrecovery may reflect low transactionvolumes and a lack of houses beingoffered for sale, rather than an
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UK economyimprovement in market fundamentals.Furthermore mortgage credit conditionsstill remain significantly tighter thanbefore the downturn.
The unemployment rate fell by 0.1percentage point to reach 7.8% for thethree months to January 2010, the firstquarterly fall in the unemployment ratesince the three months to May 2008.Nevertheless, despite recent falls inunemployment the labour market isexpected to remain weak through 2010,with continued adverse effects onconsumer confidence and spendingpower, but with a gradual improvementover time.
Consumer price inflation reached anannual rate of 3% in February, below thesurge to 3.5% experienced in January.The downward influences on annualinflation have been widespread, withsignificant downward pressure comingfrom recreation and culture.
Overall low inflation has granted somespace for the Monetary PolicyCommittee (MPC) to implement a largelyaccommodative monetary policy. In earlyMarch 2009, the MPC cut the officialbase rate to a historic low of 0.5%,where it has since stayed.
The recently announced Budgetpostponed any tough decisions on taxand spending until after the upcomingparliamentary election. The Budget
projected a slightly improved outlook forpublic borrowing. However, additionaltax rises or spending cuts building up toaround £30 billion per annum by2015/16, over and above Budget plans,may still be needed to eliminate thestructural current budget deficit by thatdate. Specifically, bond markets andcredit rating agencies will be looking fora tougher medium-term fiscalconsolidation plan to be announced afterthe general election. Moreover, whateverthe precise package adopted, publicspending is likely to be squeezed hardfrom 2011/12 onwards after a decade ofrelatively strong growth. Capital-intensivedepartments such as transport, housingand defence seem likely to beparticularly hard hit in the next spending review.
The main drivers of growth in 2010 areexpected to be exports and restocking.There should also be a gradual upturn inbusiness investment growth in 2011.However, bank lending constraints couldact as a drag on business investmentand employment growth in the mediumterm, particularly for small and medium-sized enterprises that lack other readysources of funding.
Public spending growth will remainmodestly positive in 2010, but willneed to be cut back sharply in themedium term to bring under controlan unsustainably large budget deficit.
This fiscal squeeze will act as a dragon medium-term growth but should helpto keep interest rates relatively low.Although inflation has spiked up in theshort term, we expect it to fall backtowards target over the next year givencontinued subdued earnings growth.This should allow the Bank of England tokeep base rates low during 2010.
For access to our UK economic outlookpublication and other macro-economicmaterial, register for our economicswebsite.
For further information regardingmacroeconomic advice for the realestate industry, please contact YaelSelfin, who is Head of Macro Consulting,Economics in our strategy practice.
Financial services sectorThe financial services sectoris hugely important for London,but also for many other cities inthe UK, particularly Edinburghand Bristol.
In each issue of UK real estate insightswe have reported the results of thequarterly Financial Services Surveywhich we produce with the CBI. In theprevious issue of UKREI, we reportedthat the survey to 31 December 2009had mixed messages. Although thesurvey showed sentiment continuing toimprove across the financial servicesindustry, the short-term prospects wereweaker than had been expected.
The latest survey to 31 March 2010again brings mixed news. On thepositive side, sentiment is improvingand overall there is a prediction ofgrowth and recovery. Activity in the UKfinancial service sector was broadlystable over the past three months,somewhat better than expected, andfirms hope to see much better growth inthe next three months. The profitability offinancial services businesses improvedfor the third quarter running, and isexpected to increase further in thecoming three months.
The bad news, particularly for thereal estate industry, is that overallrespondents predict falling headcountand falling expenditure on property.Furthermore there is anxiety about theUK’s long-term competitiveness, withconcern about legislative burden at an alltime high in the industry and spendingon compliance expected to rise sharplyover the next 12 months. Continued 8
Q1: Optimism versus three months earlier (% balance)
Q1: Latest +6 Previous +31 Mean +3 (Firms were again more optimistic than three months ago)
Asked how their business volumes faredin the three months to March, 43% saidthat volumes rose and 42% said theyfell. The resulting balance of +1% isbetter than the expected -13%. In thenext three months, a balance of 48% offirms expects a rise in business volumes,which is the most positive expectationsince March 2006 (+58%). While banksand security traders saw businessvolumes fall in the past three months,both sub-sectors now expect volumes toincrease in the coming quarter. Buildingsocieties and life insurers experiencedunexpectedly strong growth. Across thedifferent customer groups, business withprivate individuals grew (a balance of+5%), while lending to industrial and
commercial companies continued tofall (-9%). Volumes of business withoverseas customers rose at the fastestpace (+14%) since September 2007(+17%), and a record expectationwas recorded for the coming threemonths (+27%).
Against expectations, the value of fee,commission and premium incomerose (a balance of +14% versus anexpectation of -20%). The value of netinterest, investment and trading incomealso rose (+7 is the highest balancesince June 2007). In the coming quarter,firms also expect both these types ofincome to grow.
9
Q5(g): Trend in overall profitability % balance
Q5g: Past Latest +16 Previous +14 Mean +9Q5g: Next Latest +34 Previous 0 Mean +11
(Profitability increased at slightly faster rate thanin December)
-60
60
40
20
0
-20
-40
past 3 months next 3 months
Source: CBI/PricewaterhouseCoopers Financial Services Survey, March 2010
Q5(c&d): Total & average costs (past 3 months) % balance
Q5c: Past Latest -16 Previous -38 Mean +6 (Average and total costs both fell sharply during the last quarter)Q5d: Past Latest -28 Previous -33 Mean -12
-50
60
100
-20-30-40
20304050
-10
total operating costs average operating costs
Source: CBI/PricewaterhouseCoopers Financial Services Survey, March 2010
UK hotels forecastHotels remain an important classof investment asset for the realestate industry, and in UK realestate insights, we regularly reportthe research of our hospitalityand leisure team. In March, theypublished the latest edition ofHospitality Directions Europe.It contains our latest forecast for2010 for UK hotels and our firstlook at what might be in store for2011. We also address the criticalissue of debt restructuring andprovide the key highlights for theEuropean hotel sector fromPricewaterhouseCoopers and theUrban Land Institute’s EmergingTrends in Real Estate Europe2010.
UK hotels forecast 2010 and2011: On the comeback trail
Hotels are on the comeback trail. Moreaccurately, hotels appear to be on twoseparate trails to recovery – a super-highway for London and a much rougherprovincial trail. London stormed home inQ4 2009 and, unless it was just end ofyear exuberance, should manage tokeep the pace up through 2010,strengthening further in 2011. We acceptthat visibility is limited and the risks high,
including a public sector squeeze.But reports of higher levels of transienttravellers, more group conferencebookings and an incipient – if slow –return of business travellers are allpositive; especially for the capital, wherewe forecast 5.8% revenue per availableroom (RevPAR) growth in 2010 and afurther 7.8% growth in 2011. It is likely tobe a more difficult journey for theprovinces, where the challengingeconomic environment and a reliance ondwindling domestic business supports
prospects of a much more gentlecomeback in hotel fortunes. We forecast1.6% RevPAR growth in the provinces in2010 and a further 3.1% in 2011.
Trail ahead looks clearerfor London
After an extremely challenging18 months, we appear to have turneda corner, at least in London.PricewaterhouseCoopers’ (PwC’s) latesthotel forecast anticipates moderategrowth in demand for UK hotels, drivenlargely by London. London provedresilient in 2009 and trading turnedpositive in terms of occupancy and roomrate (just) in the last quarter of the year.In fact Q4 2009 was the highest Q4occupancy on record. We expectLondon to carry on this winning streakthrough the first quarter of 2010 at apace most cities will envy. We forecastthat London could see an occupancygain of 2.3% and rate growth of 3.5% in2010. The Intercontinental Hotel Group’s(IHG’s) recently published results forHoliday Inn and Holiday Inn Express inLondon reflect this emerging pattern,with occupancy growth from Q2 2009onwards, slowing Accounting RateReturn (ARR) declines and a small ARRgain in Q4 2009.
UK hotels forecastSome overall observations include:
• A return to UK and global economicgrowth is good news for UK hotelsand business travel volumes;
• Inbound travel declines appear tohave stabilised towards the end of2009 and the weak pound shouldcontinue to buoy up continuing leisuredemand from overseas;
• Business travel saw an unprecedenteddecline in 2009, but signs of a slowimprovement in business travelconfidence are encouraging and keyto recovery;
• Pricing power remains weak and ARRgrowth will largely reflect a reversal ofchanges in business (customer) mix,as more corporate, conference andtransient guests return, rather thanhoteliers simply raising prices;
• Counterbalancing this, manycorporate buyers negotiated hard for2010 and these corporate agreementswill exert a downward pressure onARR in H1 2010;
• London reached a turning point in Q42009 as occupancy started to stabilisefrom Q2 2009 and rise in Q4 2009;
• In the provinces, domestic businesstravel frequency has dwindled severelyand conferences and meetings willface another difficult year, but thereare pockets of good news andoccupancy declines overall slowedtowards Q4 2009.
ARR remains under pressure though,and oversupply could polarise cityperformance;
• Growth rates are perhaps not all theyseem to be – any growth is from a lowbase and comparables are poor.Inflation is expected to be relativelyhigh in 2010; however, an overlay inPwC’s forecast model incorporatessome decoupling of pricing andinflation for 2010. This is based oncurrent industry experience as higherinflation rates cannot be pushedthrough to pricing.
• It is probably self evident, buteconomic recovery is vulnerable andmay falter; public sector cutbacksare almost certainly coming and theywill impact hotels just as the privatesector business travel market starts torecover, potentially shaving off closeto 1% from UK RevPAR growth in2010 and 2011.
No chance of a fire sale:Debt restructuring prospectsfor UK hotels
Although the number of distressedassets coming on to the market isexpected to increase in 2010, as lendersincreasingly focus on clearing theirbalance sheets, a widespread fire salenow seems unlikely. Any release ofassets into the market by lenders toreduce debt levels is likely to beundertaken in a slow and controlledmanner. However, at some time overthe next three to five years, lenders willexpect to exit equity positions and thecycle of hotel property ownership willresume all over again. This articleexamines recent and expected trendsin key credit markets, hotel values,lenders’ reactions to covenant breaches,refinancing issues, the debt marketoutlook and what all this means, for newand prospective (as well as existing)borrowers.
If you would like a copy of the latestforecast or want to get on the mailing listand be kept informed about hospitalityand leisure research from PwC, pleasesend an email to Liz Hall, our Head ofHospitality and Leisure Research.
How did the budget affect real estate?Alastair Darling’s budget speechon 24 March 2010 was a preludeto the announcement of thegeneral election and, asdiscussed elsewhere in thisedition of UK real estate insights,there was much focus onsupporting an economic recovery.
Although the Chancellor’s speech lacked headline-grabbing tax changesthere were nevertheless a number oftechnical changes, mainly focused onanti-avoidance measures, with somewelcome surprises for the real estatesector.
More generally, for the first time in anumber of years there were few majorchanges impacting employee reward andtaxation, except for measures focused
on anti-avoidance. The Governmentintends to take action to prevent what itsees as attempts to avoid tax andnational insurance contributions throughthe use of Employee Benefit Trusts to‘disguise’ payments of remuneration,and other remuneration arrangements,with an eye on the additional 50%income tax rate which came into effectfrom 6 April.
With the general election announcedfor 6 May, an abridged Finance Bill 2010received Royal Assent on 8 April.A number of the proposed changes willtherefore be deferred for a newGovernment and Parliament. A further,post-election, budget is likely whateverthe outcome, and a certainty should theConservatives win.
The main changes affecting the realestate sector are discussed below.
Real Estate Investment Trusts(“REIT”) and stock dividends
After some relaxation of the REITrequirements last year in light of therecession, one further concession wasannounced following extensive lobbying.
REITs are required to distribute 90% oftheir taxable rental income in order tobenefit from exemption from tax onrental income and gains on propertysales. During the economic crisis thishas put strain on a number of REITs –mainly the smaller ones – who have notbeen able to access cash from a rightsissue and where the cost of debt hasincreased.
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How did the budget affect real estate?Stock dividends, which substitute sharesfor a cash dividend, will now counttowards a REIT’s 90% requireddistribution. The key benefit for REITs isthat they can conserve cash. There willbe a choice for shareholders, who cantake shares as an alternative to cash.However, the stock dividend will betaxed as if it were a cash distribution.Withholding tax would be factored intothe pricing, although UK charities, UKinstitutions and UK corporates would notsuffer this tax. Taxpayers would besubject to tax at their highest rate.
Aside from the cash flow benefits to theREIT if taken up, the uncertainty wherestock dividends have previously beenpaid (caused by not knowing what thetake up would be, and the risk thatfurther ordinary dividends would needto be paid) will now be removed.
Although there is no reason to believethis change should be contentious –the tax take through withholding tax isunaffected – legislation has beendeferred to a Finance Bill in the nextParliament and therefore has yet totake effect.
Stamp Duty Land Tax (“SDLT”)
The government has de-coupledresidential property from commercialproperty with the new rate for SDLT of5% for houses over £1m (albeit from
6 April 2011). The clear intention is toself-fund the newly announced SDLTholiday for first buyers for housing up to£250,000, but is this the start of furtherincreases at the upper level?
There are also concerns in thecommercial property industry as to howthe new anti-avoidance rules forpartnerships will apply. Propertypartnerships have been a mainstreammethod of investing for many years as
they enable investors with differentprofiles to invest through a transparentstructure. This ensures that tax-exemptinvestors such as charities andcertain institutions do not suffer tax.Consequently, SDLT saving was nota key driver for all such structures.The legislation indicates that allpartnerships are caught by these newprovisions regardless of the rationale forthe property structure, although some
assurances have been received thatinnocuous transactions should not becaught and further guidance is expected.
These SDLT changes are now enacted aspart of the abridged Finance Act 2010.
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How did the budget affect real estate?
Uniform Business Rates
The announced changes to the smallbusiness rate relief scheme from 1October 2010 are for one year only andwill be limited to the very smallbusinesses that currently qualify underthe scheme. No additional ratepayers willbe able to benefit from this smallextension of relief. The smallestbusinesses with rateable value below
£6,000 will benefit up to a maximumone-off reduction of around £1,200because they would have already hadrelief at 50%. They will now pay no ratesfor a year.
The small business rate relief schemereally only benefits sole traders, as theeligibility criteria are focused on thosetype of businesses where incorporationwould probably be an undue burden.
Accelerated Development Zonepilot programme to be launched
The Government announced that it willbe issuing a £120m grant to support theimplementation of an AcceleratedDevelopment Zone (‘ADZ’) pilotprogramme across England.
The key principles that underpin theADZ policy focus on the deploymentof the projected future tax gains ofproposed urban regeneration schemesto finance the infrastructure required tounlock the schemes themselves. Forexample, a public project such as theconstruction of major new transport linksor the provision of new educationalinfrastructure can lead to an increase inthe value of surrounding real estate, andoften new and additional investment inthe area. This increased site value andinvestment creates more taxableproperty, which in turn increasespotential tax revenues. In an ADZ, theseincreased tax revenues would be used tofinance debt issued to pay for the initialinfrastructure development. In this way,local authorities will be able to use theproceeds of future growth to enabledevelopment in the first place.
Impact on inbound investmentinto UK real estate
With few major changes the UKcontinues to be an attractive tax regimefor non-residents investing in the UK,with, typically, no tax on capital gains,a tax rate on income of 20%, anddeductions for capital allowances (or taxdepreciation) and interest on loans madeon arm’s length terms.
The basic income tax rate for non-resident investors remains at 20%, andalthough the already announcedadditional rate of 50% will be introducedas intended, this will typically only applyto high-income individuals or to certainoverseas pension schemes investing inUK properties. The personal allowancesavailable to UK and certain non-UKresidents are frozen at the 2009 level.
Tim Jones is a Director in our real estatetax team.
Government consultation: Investment in the Private Rented SectorThe Government issued aconsultative document earlier thisyear ‘Investment in the privaterented sector’ which addressesthe past contribution which theprivate rented sector (‘PRS’)made to the provision of housingthrough buy-to-let and otherinitiatives.
The Government’s stated agenda is tohave a flexible and responsive housingmarket. However, following the recentdownturn, there is a concern that thesupply of housing has significantlydecreased “making achievement ofGovernment objectives morechallenging”. Consequently, Governmentis seeking views on whether the PRS canmaintain its current level of housingsupply and what the barriers are toinvestment in the PRS when comparedwith commercial property.
To put the housing supply problem incontext, here are some key statistics.The number of households, that totalledaround 21.5m in 2006, is predicted togrow to over 27m by 2031, which meansthat 220,000 new units haveto be supplied each year to meet thedemand. However, even at the heightof the housing boom in 2007/8 annualcompletions only reached 168,000and they are expected to have fallen toaround 100,000 in 2008/9, accordingto ‘Mind the Gap – Housing Supplyin a Cold Climate’, published byThe Smith Institute, Town and CountryPlanning Association andPricewaterhouseCoopers LLP.
One of the key benefits of the buy-to-letinitiative was the increase in newproperties entering the PRS. Based on asample of buy-to-let mortgages taken outbetween 2004 and 2007, it is estimatedthat around 10 per cent of loans were fora new property. In 2007 this would haverepresented 35,000 out of 182,800houses or around 20% of new housing
(Buy-to-let Mortgages and the impact onUK house prices National Housing andPlanning Advice Unit 2008). However,the consultation document acknowledgesthat this was a peak for the buy-to-letmarket with a reduction since thenalthough no statistics appear to beavailable.
However, in the medium term there isexpected to be a continuing tighteningof mortgage credit (with loan to valueratios stabilising at c 80%). This factoralongside the fall in the productioncapacity of house builders, means thatthe rate of housing growth is unlikely toreach 10% per annum. If it falls below5% it could take until 2025 before morethan 200,000 homes are being addedannually to the housing stock (HousingRequirements and the Impact of RecentEconomic and Demographic Change,National Housing and Planning AdviceUnit (NHPAU 2009).
Concerns over macroeconomic fragilityand the supply of housing for sale (inaddition to the limited ability of theGovernment to intervene on any scale toaddress this market failure) have led theGovernment’s housing investmentagency (the HCA) to assess the appetiteof institutional investors to invest in thePRS. Significant funds are available forinvestment by institutions but they do notgenerally invest in housing. Today thereare very few institutions with significantresidential property, and only one quotedcompany. Successive rent acts, startingafter World War I, reduced rental incomethrough ‘rent controls’. The reduction in
income, coupled with management costsand reputational risk (for example if anelderly widow were seen to be evicted bya well-known institutional investor,) ledinstitutions to invest in commercialproperty and other diverse assets.
Then there is the proverbial yield gap –the difference between the return fromcommercial property and residentialincome. Commercial property can bepurchased in large chunks with littlerelative cost, a one-off stamp dutyland tax cost and little managementrequirement. The tax regime isbenevolent with potentially full recoveryof VAT and capital allowances forimprovements. In contrast residentialproperty relates to people’s homes andrequires more intensive managementagainst a backdrop where the tax regimeis less sympathetic.
Turning to the consultative document,we are currently working closely with anumber of clients and industry bodiesto develop proposals to Government onhow improvements could be made toresidential investment from a numberof perspectives. These range from animproved tax regime through to moreeffective planning.
The deadline for consultation is 28 April,2010. Improvements in the PRS can onlyresult from a concerted effort from theindustry.
Rosalind Rowe is a partner in ourreal estate tax team.
Changing investor demands: Can you demonstrate that your operatingmodel is fit for purpose?
The last two years have been achallenging period for real estateinvestors. Historically, in risingmarkets investors focused onoutright performance alone; andso long as performance wasimproving, relatively little focuswas given to the risk and controlsbeing operated by real estatefund managers.
Two years ago, PwC and the EconomistIntelligence Unit published the survey‘Transparency versus returns: theInstitutional investor view of alternativeassets’, Insitutional investors fromaround the world were asked their viewson investment in alternative assetclasses, including real estate. Accordingto the respondents, performance was, by
a wide margin, the key criterion whenselecting a service provider across thealternatives sector. However, even then,when deselecting a service provider,performance (or lack of it) ranked equallywith quality of compliance and riskmanagement process, transparency andquality of reporting. Whilst goodperformance would generally get you
selected as a service provider, failingsin other areas could lose you themandate. Furthermore, institutionalinvestors had been more tolerant ofother weaknesses when returns hadbeen strong. Even two years ago, theirtolerance was weakening along with thereturns. The two years since then havegiven time for investors to crystallisetheir views, and now there is a real focuson wider performance measures, betterunderstanding of the risks of underlyinginvestments and critical assessmentof the control environment, both atthe real estate manager and theunderlying assets.
As reported elsewhere in this editionof UK real estate insights, cautiousoptimism is returning to real estatemarkets and investment capital isreturning. It is expected that any futureinvestment will come with some caveats– there will be a demand for strongergovernance, risk and control processesand, perhaps more importantly, theinvestors will need to see this throughtransparent and effective reporting.Demonstration of a strong controlsenvironment is key.
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Changing investor demands: Can you demonstrate that your operatingmodel is fit for purpose?
This article will focus on some of thechallenges faced by organisations torespond to these changing investordemands.
Current investor reporting
There is a broad spectrum across themarket in respect of the extent of detailedunderstanding, monitoring and reviewundertaken by investors in respect of theirfund managers or Investment Partnersand the underlying investment assets.Those at the ‘best practice’ end of thespectrum are able to demonstrateeffective risk management and mitigatingcontrols, as well as expressiveperformance of their underlyinginvestments in a clear articulated way. Atthe opposite end of the spectrum,investors may struggle to understandanything other than absolute return orprojected returns on their investmentsand so are not necessarily aware of all theassociated risks. There has been arecognition that those at the lower end ofthis spectrum need to catch up quickly inorder to demonstrate better control and governance across their ownreal estate investment portfolios.
A focus on operational reporting
The focus is moving to operationeffectiveness. Some key questions toconsider should be:
1. Are the operating systems andprocesses of the underlying fundmanager and through to theunderlying investments fit for purpose,providing accurate and timelyreporting?
2. Is the underlying business compliantwith the regulatory and governanceneeds of investors?
3. Is the underlying business flexibleenough to remain compliant with anincreasingly complex regulatoryenvironment, for example the EUDirective on Alternative InvestmentFund Managers discussed elsewherein this edition of UKREI?
4. Can the business model adapt andflex quickly to changing marketenvironments?
5. Do I understand all the risks and howthey are controlled and managed?
6. Can I demonstrate to others myunderstanding of the above?
For these questions, the investor shouldbe in a position answer these questionsat any time through the investment cycle.And as a result of these questions,investor expectations of the quality andtimeliness of reporting are changing.
There is an acknowledgement by mostinvestors that to make significantchanges to the extent of reportedinformation on their current investmentswill be difficult, not least because theinformation they receive is alreadyestablished legally through theirinvestment contracts.
However, for fund managers wishing toattract new money, investors see this asan opportunity to bring about change,bringing in new areas of reporting toensure that appropriate governance, riskmanagement and operational control canbe demonstrated to them by the fund
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Changing investor demands: Can you demonstrate that your operatingmodel is fit for purpose?
manager. Many investors are alsoindicating a move away from a relativelypassive, responsive approach to realestate investment to one that is far moreactive in terms of regular monitoring,periodic reviews and more robustchallenge throughout the investmentcycle; from the due diligence phasethrough to final exit or realisation.
New investments, new demands
A number of investors have indicatedhow their needs are changing and whatinformation they will require on futuredeals. There is general consensus thatthe increasing information requirementsand focus on effective risk managementwill be a gradual change over a period ofmany months.
However, their objectives and vision areclear, and we set out here some of theareas of focus both at the initialinvestment stage but also in the ongoingmonitoring and assurance that investorshave indicated they would like goingforward:
Investment due diligence
The following highlights areas whereinvestors believe they will need to spend
significantly more time and effort tounderstand the underlying operations toenable them to agree that the operatingmodel is fit for purpose.
• Overall governance structures,including assessment of key reportinglines, oversight of any outsourcedoperations, including any associatedservice level agreements andmandates;
• The operated model process flow,including the quality of informationand ability to gather data;
• The flexibility of the operating modeland its ability to change to meetunexpected demands or significantmarket changes;
• Risk management and compliance –the size, quality and depth ofexperience of individuals within the
team, along with areas of focus,reporting lines and coverage. Thequality, reliability and transparencyof the reporting processes;
• The activity of any internal audit-typemonitoring and review function, eitherinternally or outsourced, includingtheir findings and the organisation’sresponse to those findings;
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Changing investor demands: Can you demonstrate that your operatingmodel is fit for purpose?
Ongoing monitoring bythe investor
There is an expectation that investorswill establish or enhance their ongoingperiodic monitoring of investments, thisbeing a historic area of weakness.Such monitoring reviews are expectedto include:
• The quality and accuracy of theregular reporting provided;
• Obtaining an understanding of andgaining assurance against knownissues and understanding how anyremedial actions or recommendationshave been implemented by themanagement team.
• Validation of the effectiveness of keyongoing control processes.
Investors are also expecting to enhancetheir understanding of the operationalrisks surrounding their investments andthere is an expectation that ongoinginformation requirements may in futurecover aspects such as human resources,IT, procurement processes, health andsafety, and sustainability.
This is alongside the more traditionalrequirements such as financialperformance; however, even in this area
there is an expectation of betterassurance being provided to the investorover the quality and accuracy of theinformation and a greater understandingof the more significant risks to thebusiness.
Responding to investor demands
So how are real estate fund managersresponding to these demands?Management teams are focused onimproving the operational effectivenessof the organisation, usually throughinvestment in systems, improvinggovernance and oversight, establishinga more structured approach tooperational processes and controls,linking risk management and enhancingreporting. In addition, where no functionexists, establishment of an internal audit-like function to monitor thebusiness and provide an independentview on the effectiveness of key controlsand processes.
External reporting to investors isbecoming more common practicethrough the use of independently verifiedcontrols reporting such as Statement onauditing Standards (SAS) 70 typedocuments or the UK equivalent AAF01/06. Whilst most traditional assetmanagers have been required to
demonstrate the effectiveness of theirinternal controls by providingindependently audited controls reports(SAS 70, AAF 01/06 etc) to institutionalinvestors for many years, real estate fundmanagers have not had the samedemand. As a result, even though anumber of large, multi-asset managershave included property in their controlsreports for the sake of completeness, wehave not seen many standalone reports.However, this trend is changing. One ofour real estate fund clients, managing arange of direct and indirect propertyfunds, has responded to the demandsfrom its largest institutional investor (inthis case, a pension fund) by producingan AAF 01/06 report covering its UK realestate funds, for which PwC act asreporting accountants. Others areconsidering following the same path asthey too are finding their institutionalinvestors becoming more insistent ontransparency over management ofoperational risk. At the moment, it is fairto say that these clients consider theirreports to be providing them withcompetitive advantage. However, if thetrend we have seen in other assetmanagement sectors translates acrossto real estate, then we would expect acontrols report to become a requirementfor those wishing to manage assets forinstitutional investors. The good news is
that, aside from satisfying clientdemands, our clients report significantbenefits arising from going through therigorous assessment required for acontrols report, both in terms oftightening up their control environmentand in identifying areas of efficiency.
For some this change in investor mindsetis seen as an opportunity to differentiatetheir organisation and to capitalise onthe perceived value of real estateinvestment, particularly in the UK market.To be able to meet these investordemands and demonstrate theorganisation’s ability to deliverperformance in a controlled way willdifferentiate any fund manager orjoint venture partner going forward.
Christian Bellairs is a Director and leadsour Risk Control and Internal Auditservices to the asset managementindustry in London.
Regulation for the real estate industry –Alternative Investment Fund Manager Directive
As discussed in the introductionto this edition of UK real estateinsights, and in previous editionsof this publication, the real estateindustry across Europe is facingregulatory burden as theEuropean Union seeks to controlthe activities of AlternativeInvestment Fund Managers(‘AIFMs’).
In the previous edition of UK real estateinsights, we noted that following theinitial release of the draft AlternativeInvestment Fund Management Directive(‘The Directive’) in April 2009 and thegeneral consternation which resulted,both the EU Council and the Parliamenthave deliberated the proposedprovisions and have produced their own
position papers or drafts. In this latestarticle on the progress of the Directivethrough the EU legislative process wewill provide an update on the currentposition and where the timetable nowstands for implementation.
We recently published our latestnewsletter on the open issues andnegotiations in relation to the Directive.It sets out in some detail the majorpoints of contention at the time ofpublication. These principally relate tothe overall scope of the Directive, theprovisions relating to depositaries andthe position of non-EU AIFMs (theso-called ‘third country’ provisions).
This article will deal in the most part withspecific real estate issues – however,it is worth summarising the three issuesaddressed in our newsletter.
Scope – there seems to be a weight ofopinion behind the need for some sort ofthreshold or limitation on the applicationof the Directive. The Commission andPresidency have opted for thresholdsbased on assets under management,whereas the Parliament has so farpreferred so far a principle ofproportionality coupled perhaps withsome defined thresholds. There arehardliners in both camps who wouldprefer to see no limits whatsoever.
Depositaries – there is still somedivergence of view on the type ofinstitution which may be a depositary,
Regulation for the real estate industry –Alternative Investment Fund Manager Directive
the standard of liability required andwhether it is critical that the depositaryneed be established in the homemember state of the AIFM. Someflexibility of approach seems to bedeveloping and we await final versions ofParliament and Council documentation.
Third countries – discussions onmarketing in the EU by AIFMsestablished outside the EU still progress.The current approach suggested by theParliament is for national regimes toapply for a transitional period with cross-EU marketing only allowedthereafter where ‘equivalence’ ofregulatory provision or a similar conceptcan be shown by the third country.
So, what does this all mean in thecontext of the real estate industry andsome typical structures that we see?
As drafted, the Directive catches a verywide range of co-investment structures –most of which present little or nosystemic risk or do not require anyprotection for the investors involved.For example, as currently drafted, theDirective will seek to regulate a UKcorporate joint venture where twoindependent groups come together toinvest jointly in UK property. There needbe no more than two and the investingcompanies may remain entirely in control
of the investment decisions and thedevelopment, letting or other use of theproperty. There is some indication thatthe Commission may be sympathetic tothe need to exclude this type of propertyinvestment. The currently proposedthresholds will not of themselves assistas they are too low to catch most formsof commercial real estate investment.The problem would not have arisen ifthere were an exclusion for thoseproperty transactions where thoseinvesting retained day-to-day controlover the investment vehicle and somechoice or discretion over investmentsmade. However, that sort of limitationwhich is provided in the UK definitionof a collective investment scheme has sofar been rejected by the Commission.
There is little sympathy in Europe forthe exclusion of listed property vehicles,including REITs, and they will beincluded despite strong representationby the British Property Federation andother representative bodies.
There was considerable concern thatany co-investment in property, howeversmall, could be caught under someversions of the Directive which containedno limitations by reference to size ofinvestment, risk to size of investment,risk or any other criterion. As seenabove, it is currently expected that there
will be either some threshold exemptionsor a limitation based on the principle ofproportionality, although it is thoughtharder to achieve the latter in thedrafting.
It is unclear whether and to what extentthere will be any grandfatheringprovisions which would effectively
exclude existing structures. Even if someare introduced it is thought highly likelythat the date for these has alreadypassed and that any new funds orinvestments being set up now will berequired to comply with the Directiveonce it comes into force.
Continued 21
Simple JPUT (Jersey Property Unit Trust)
Source: PricewaterhouseCoopers
Investor B
UK PropertyE
UK PropertyD
UK PropertyC
UK PropertyB
UK PropertyA
Investor A
JPUT
UK Manager
Trustee (Jersey Co)
Administrator(Jersey Co)
UK real estate insights HomeQuitPrint
Regulation for the real estate industry –Alternative Investment Fund Manager Directive
We turn now to a number of typical realestate structures for real estateinvestment with which readers will befamiliar.
This represents a standard form ofinvestment into UK property. The JerseyPoperty Unit Trust (JPUT) structure isboth tax efficient and commerciallydesirable in the right circumstances. Forthe purposes of AIFMD there are severalissues. The manager who will berequired to be authorised could be eitherthe UK manager or thetrustee/administrator of the JPUT. UnderAIFMD an entity is the manager of thefund where it is responsible for portfoliomanagement and risk management. Onthe basis that management for thispurpose requires the exercise ofdiscretion then it is unlikely that the UK‘manager’ will be the manager for thepurpose of the Directive. For taxpurposes it is normally important that theUK adviser or manager does notexercise discretion or have the right totake decisions of any importance inorder to avoid a UK taxable presence.This leaves the Jersey trustee as theentity with investment discretion andtherefore as the manager in thisstructure. The JPUT itself is clearlyestablished outside the EU. The thirdcountry rules will apply here if themanager is indeed not in the EU. Given
the moving parts that remain and thelack of detailed rules (these will notappear until some time later,) whetherthis is a good or a bad result is as yetunclear. : A marketing passport wherethe manager is not in the EU is unlikelyto be available for some considerabletime, but in this type of structure, with alimited number of investors intended,
that may be irrelevant. There is no easilyidentifiable depositary here, although in anon-EU structure it is unclear whatdepositary or equivalent arrangementsmay be required. If the units in the JPUTare to be marketed in the EU thencompliance with some provisions of theDirective (particularly around reporting)may be required.
The lack of clarity in terms of scope andthird country rules if not resolved willcreate a difficult commercial environmentfor third country structures where EUinvestors are deemed desirable.
A second, very typical, structure forinvestment in UK property is the Englishlimited partnership with a general partner(GP) located either in the UK orelsewhere – typically in the ChannelIslands.
It is likely that the general partner willhave the investment discretion in relationto the partnership affairs and willtherefore be the manager in terms of theDirective. Where the GP is located willtherefore determine whether there is anEU or non-EU manager in relation to thefund, i.e. the limited partnership. Themanager established in the EU willrequire authorisation and need to complywith all the provisions of the Directive.It will then benefit from more freedom tomarket, although the ongoing reportingrequirements are more onerous thanunder existing rules. A depositary willalso be required – in the current draftsthe obligations are onerous and liabilityintended to be strict. Whether thecurrent custodians will be prepared to
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Simple English (non-EU GP)
Source: PricewaterhouseCoopers
Investor A
Investor B
Fund(English LP)
InvestmentAdvisor A
UK
InvestmentAdvisor B
UK
GeneralPartner
(non-EU)
49.5%
100%
49.5%
49.5%
0.5%
0.5%
49.5%
1%
UK real estate insights HomeQuitPrint
Regulation for the real estate industry –Alternative Investment Fund Manager Directive
undertake these responsibilities is opento debate, and they will in any eventcharge a higher fee if they do. A non-EUmanager may seem a more attractiveoption where there is no intention tomarket widely in the EU – if the nationalrules of the relevant jurisdiction are toapply at least for the time being until an‘equivalence’ regime is introduced inseveral years’ time, some funds mayprefer the less onerous reporting andauthorisation regime at the expense ofthe marketing flexibility.
Again, the current problem for theindustry is that there is insufficient clarityand certainty to enable fully informeddecisions to be taken.
There are of course a plethora of otherstructures which could be set out andanalysed, but it will be apparent fromthe above that there are a host of issuesto consider in relation to the terms ofthe current Council draft Directive.The difficulty when contemplating anynew initiative is that the final positionis unclear and is subject to manyalternatives still under discussion.Traditionally many real estate fundmanagers have sought to avoid theburden of regulated vehicles, such asthe various Luxembourg fund entitiesdiscussed elsewhere in this edition of
UKREI. Many fund managers in theEuropean Union are increasinglyaccepting the inevitability of regulation,and therefore the old strategy of avoidinga regulated fund vehicle becomes ratherless relevant.
The best advice in considering any newarrangements at present must be toretain maximum flexibility so that, to theextent possible or necessary,
adjustments can be made as theDirective is finalised and the secondarylevel of detailed regulation is put inplace. We should know within the nextfew weeks whether there will be a finalform of Directive by the summer. Oncethe form and content is clear it will beimportant to start to assess the likelyimpact on existing and plannedstructures.
Amanda Rowland is a partner in ourReal Estate team who is considering withclients the potential implications ofAIFMD on existing and proposedinvestment structures.
Real estate and the UK offshore funds rulesThe United Kingdom has had aspecial tax regime for ‘offshorefunds’ since 1984, the rules beingdesigned to restrict the capacityof UK investors to accumulateincome offshore and tosubsequently realise the returnas a capital gain.
As previously reported in UK real estateinsights, the Government announced anoverhaul of the regime in the 2007Budget. Changes to the offshore fundsanti-avoidance legislation weresubsequently introduced that apply tonew investments made by UK taxpayerson or after 1 December 2009, with animportant election of treatment to bemade by taxpayers by 31 May 2010.The historic legislation generally did notcatch real estate funds.
Under the new legislation HMRC haswidened the definition of an offshorefund such that a broader range ofentities can now fall into the rules.
• Partnerships are not within the scopeof the rules, but investors are requiredto look down to lower tier entities untilthey reach a non-transparent entityand then test whether that entity is anoffshore fund;
• The legislation is drafted such thatnon-UK corporate entities can fall intothe regime;
• Each share class or class ofinstrument in the offshore entity mayitself count as a separate offshorefund;
• Grandfathering rules are available toprotect certain pre-existingarrangements;
• Transparent funds do not have to electinto the regime providing they makeavailable enough information toinvestors to enable them to includethe fund’s income within their own taxsubmissions. This exemption alsorequires that the fund does not holdmore than 5% of its assets in othernon-reporting offshore funds. This caninclude non-UK corporate specialpurpose vehicles (SPVs) and holdingcompanies and will need carefulreview/monitoring.
The change in definition could bring realestate fund entities, including theirunderlying holding companies, into theregime. As with the old rules, where anoffshore fund doesn’t comply with thereporting fund regime, a UK investor’scapital gains on exit from that fund willbe taxed at income rates of 50% ratherthan 18%. As well as impactingadversely on UK fund investors thiscould have a very significant impact onreal estate carry and co-investstructures.
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Real estate and the UK offshore funds rulesThere has been significant uncertainty asto how HMRC would seek to apply thedefinitional provisions in the OSFlegislation to interests in non-UKcorporate vehicles. The legislation asdrafted provides for significant doubtthat an open-ended corporate vehicleheld by a closed-ended fund falls out ofthe definition of an offshore fund. HMRChas expressed privately the view thatprivate equity fund structures will (inmost cases) be out of the regime but hasnot provided the same assurances forreal estate funds. We are waiting fordetailed guidance as to how HMRCintends to apply the law in this area.
Of particular importance will be theviews around whether an investor couldexpect to realise their return by referenceto Net Asset Value (NAV). This isexpected to be the carve out that mostprivate equity funds will rely on (i.e. theyinvest in underlying trading businessesand therefore NAV is a not a good proxyto expected realisation value). It is moredifficult to apply this carve out to realestate funds given that the structurestypically do not involve trading activities.Where an investor can expect to realisetheir return by reference to NAV at anytime other than liquidation, the entity isalmost certain to be an offshore fund.Where it is determined that realisationsare expected to be by reference to NAV,real estate funds and the underlyingentities would also be excluded from the
regime in cases where the investors donot expect to realise at NAV untiltermination/wind-up, and where otherconditions apply, such that either;
• The arrangements do not have anexpected wind-up date built into thegoverning documents or constitutionof the entity; or
• If the arrangements do have anexpected wind-up date the assets are
not income-producing assets, thearrangements have no right to incomein the structure or there is arequirement to distribute all income asit arises from the arrangements to theinvestors, such that UK investors aretaxed as the income arises.
Where the governing documents of thefund (e.g. such as the limited partnershipagreement for a limited partnership fundvehicle or equivalent) have a
determinable date of termination, it islikely that a corporate vehicle withoutsuch date in its own articles is likely tofail to meet the first of the above tests.
The majority of real estate fundstructures (and in particular theirunderlying holding structures) would nothave been offshore funds under the oldrules. Where that is the case the fundhas until 31 May 2010 to decide whetheror not to elect into the reporting fundregime for an accounting periodbeginning 1 January 2010. Thesignificant uncertainty around thedefinitions and HMRC's application ofthe rules is likely to lead to many fundselecting funds into the regime to providethe required certainty.
Andrew Smith is a director in ourReal Estate Tax Team
Tenant administration: the least attractive option of several evilsTenant distress grabs theheadlines in the property press.Until recently, much of theattention was on the use, andpossibly abuse, of pre-packadministrations.
More recently attention has focusedon Company Voluntary Arrangements.Very little attention has been paid to athird option, Schemes of Arrangement.This article takes a brief look at allthree options.
As discussed in this and other editionsof UK real estate insights, real estatemarkets have had a turbulent two years,with the UK being hit particularly hard.This turmoil has been brought into sharp
focus by retailers such as Adams and,of course, Woolworths coming to theend of the road and using administrationprocedures as a method of realisingvalue for creditors. As discussedelsewhere, although real estate investorsare increasingly optimistic, there remainoccupiers facing a challenging future.
When a company is put intoadministration, rent and other obligationsunder a lease are treated as an
unsecured debt and, along with othercreditors, landlords are likely to receiveonly a proportion of what is owed (albeitmany administrators pay rent as anadministration expense for the period inwhich the insolvent company occupiesthe premises).
The recent Nortel case confirmed thatrent is automatically payable as anadministration expense where theinsolvent company continues to occupythe premises. It has changed thedynamics in favour of the landlord byruling that the rent payable could not bemitigated where the premises were onlypartially occupied by the insolventcompany and that where a quarter dayfalls due whilst the insolvent company isin occupation, rent for the whole quartermust be paid regardless of earlyvacation.
The flip side might be that administratorswill argue that regardless of any unpaidrent predating the administration, no rentis payable by the insolvent companyuntil the next quarter date is reached,and nothing at all if occupation ceasesbefore that point. The Nortel decision willclearly affect pre-insolvency planningand may encourage consideration ofdifferent solutions to a cash crisis. It willbe interesting to see if this case law isoverturned, as the case has a number of
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Tenant administration: the least attractive option of several evilscomplications and does not deal with thewhole landlord/tenant relationship, forexample over tenant obligations inrespect of areas such as dilapidations.
In 2009 there were 4,161administrations, of which approximately29% were pre-packs (where thebusiness sale deal was agreed preinsolvency and executed immediatelyupon administration) based uponStatement of Insolvency Practice (SIP)16 reports reviewed by the InsolvencyService. Such sales are often tomanagement, leaving theunderperforming part of the business tobe disbanded. This type of insolvencyprocess has dwindled over the past fewmonths along with insolvency volumes,Q4 2009 down 5.5% on Q4 2008).
However, retailers such as JJB, Blacksand Speciality Retail Group have allneeded to carry out major restructurings,(mainly driven by underperformingstores) in order to secure the long-termviability of the business. Thesecompanies have chosen to use aprocess known as a Company VoluntaryArrangement (CVA) which has increasedin popularity as the bottom of theeconomic cycle has been reached.The impact upon their store estate hasbeen marked and landlords have beenleft with little option other than to takeback stores. The impact on the landlordis even more pronounced where stores
are situated in shopping centres and thecost of empty rates and void servicecharge has to be absorbed in addition tothe loss of rental income.
Company Voluntary Arrangements
For those not familiar with CVAs,it is an insolvency process which canbe proposed by the directors, anadministrator or a liquidator and hasthe following key features:
• It is a proposal made by a companyto its creditors ‘for a composition insatisfaction of its debts or a schemeof arrangement of its affairs’;
• A CVA may not affect the rights ofdissenting secured or preferentialcreditors;
• All of the company’s creditors andmembers must be given notice of theCVA meetings;
• If approved by the creditors andmembers, the CVA becomes a legallybinding agreement, and it is only liableto be set aside where a creditor isunfairly prejudiced by thearrangement, or where there has beensome material irregularity in relation tothe CVA meetings.;
• There is no court involvement; theentire procedure takes place outsideof court;
• The CVA is supervised by a qualifiedinsolvency practitioner (IP). It typicallylasts for a number of months, and isconsidered to be a formal insolvencyproceeding.
Much has been written over the pastcouple of months in relation to the use ofCVAs, with comment being made inrespect of the rights and wrongs oftenants in multiple locations using such
a process to rid themselves of the ‘rump’of the portfolio.
Those tenants would argue that theuse of a CVA or an alternative insolvencyprocess such as a ‘pre-pack’administration allows them to createa viable business, as opposed tostumbling along on the brink of
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Tenant administration: the least attractive option of several evilsinsolvency. However, landlords face theprospect of the burden of a propertybeing passed back to them without atenant and without a rental stream,along with the additional financial liabilityof empty rates.
It is a bitter pill for landlords to swallow,but the fact remains that a weakproperty market gives rise to theopportunity, and underperforming storeseventually destroy the business bystarving the performing part of thebusiness of cash which could beinvested in product etc. eventually
creating disaffected management.Maintaining a reduced cash flow andlimiting outgoings is a better optionthan no rent and a rate and servicecharge liability.
There certainly seems to be anincreasing awareness of their existencegiven the number that are beingreported, and this in turn is drivingvolumes as companies explore theoptions open to them.
Schemes of Arrangement
Given the hostile response in theproperty fraternity to CVAs, analternative approach, the Scheme ofArrangement (‘Scheme’), seeks to createthe transparency necessary for thoseaffected parties to make a ‘commercial’decision and is a more consensualoption, given that each class of creditor,of which landlords may form one, needsto approve it.
A Scheme is a compromise or anarrangement between a company’smembers and/or creditors and variesfrom a CVA in the following ways:
Scheme
• Most importantly it is a CompaniesAct, not an Insolvency Act, processwhich means less stigma for thecompany involved;
• It is also a binding agreement betweenthe company, its creditors and itsmembers;
• The substance of the agreement isvery flexible and has virtually no limits.Even the rights of dissenting securedand preferential creditors may beaffected;
• Only those creditors/members whichare affected by the Scheme must begiven notice of the Scheme meetings.
The company’s remaining creditorsand members need not be informed.
• If the Scheme is approved by thecreditors and members, it must thenbe sanctioned by the court, and inorder for an applicant to be in aposition to petition the court forsanction of the Scheme, the Schememust have been approved at meetingsof creditors and/or members by(i) a majority in number which (ii)represents 75% in value, of thecreditors/members (as the case maybe) present and voting either in personor by proxy;
• The court is involved. Since there arecourt orders, international recognitionof the proceedings is more easilyfacilitated;
• The directors of the companyremain in control; and an InsolvencyPractitioner’s involvement is strictlyunnecessary and, if used, verylight-touch and often limited toadvisory work;
• A key difference between Schemesand CVAs is the division of votingcreditors and members into classessuch as a landlord class.
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Tenant administration: the least attractive option of several evilsSince a CVA is very much considered analternative to administration, a companymay be of the view that to implement aScheme may not give rise to the samedegree of stigma that would arise were itknown that the company had enteredinto a CVA.
Summary
There is no right answer on whether aCVA, Scheme, or indeed a commercialcompromise should be pursued, and thesolution should be determined based onthe merits of each against the interestsof stakeholders.
However, those who have been involvedin Schemes before more readily seemerit in a Scheme as an appropriate wayforward given its inherent flexibility andmore consensual process, particularlywhere a specific interest group wouldconstitute a separate class such as aLandlord group.
What is clear though is that practitionersshould explore all possible options toensure they can deliver the best result tostakeholders and not just follow thenorm because it is a seemingly saferoption. Inevitably, there will be winners
and losers – there always are whenfinancial distress is present and there isinsufficient cash to go round. However,Schemes do seem to provide anopportunity for an entity to maintain thecurrent management, critical businessrelationships and stakeholder confidencein the business, thereby ensuring arobust supply chain. All of these help tocreate a viable entity that is able to honour its commitments intothe future.
However, one thing that we are yet tosee is a ‘body of landlords’ groupingtogether and seeking representation inrespect of either a CVA or a Scheme.Perhaps that will be the next trend.
Mike Jervis is a partner in our BusinessRecovery practice. He is currentlyadministrator of most of the UK’s largestinsolvencies, including the 19 LehmanBrothers English entities in formalinsolvency, Enron Metals and ParmalatUK. Deborah Parker is a CharteredSurveyor in our Business Recoverypractise. She has 20 years of real estateexperience with most of that gained onthe client side, where she has heldProperty Director roles in both hotel andretail companies.
Emerging Trends in Real Estate EuropeEmerging Trends in Real Estate®Europe, is one of the EmergingTrends reports publishedeach year by the Urban LandInstitute (ULI) andPricewaterhouseCoopers, theother reports being for NorthAmerica and Asia-Pacific.
All three reports are based on face-to-face interviews with seniorrepresentatives from the real estateindustry, including investors, developers,financiers and fund managers.The interviews are supplemented byelectronic surveys. The seventh annualreport for Europe, published in February,is based on over 250 face-to-faceinterviews and over 350 surveys to givea consensus view of well over 600 of theleading figures in the industry.
Europe’s real estate industry in for‘long, slow haul’ to recovery
The report shows that sentiment isstabilising, although there is cautionabout the progress of recovery. Withsome credit easing and property valuesstabilising, Europe’s real estate industryviews 2010 with ‘cautious optimism’, butstill faces a ‘long, slow haul’ to recovery.
Overwhelmingly, respondents cite asreasons for caution two broad concerns.Firstly the economy – as Europe’seconomy remains fragile and there isuncertainty over how, and when,European governments might wean theirrespective economies off the massiveinjections of state support. An abruptwithdrawal of the stimulus funds couldderail the recovery, and even push theeconomy back into recession. As onerespondent commented, ‘If quantitative
easing and fiscal stimulus are the heroin,what’s the methadone?’ Additionally, thereport notes the looming problem of therefinancing of commercial real estateloans from banks and commercialmortgage-backed securites (CMBS)conduits rolling over from 2012 to 2014.Again a respondent observed, ‘There’s ahuge problem coming over the hill.’
Stabilising sentiment
Sentiment regarding investmentprospects has stabilised, and althoughsentiment regarding developmentcontinues to decline, it is a less dramaticfall than that witnessed last year.The key issue is the occupier side of theequation. Investors are nervous and theyare concentrating on the deeper, moreliquid markets.
Germany is viewed more favourably forinvestment and development activitythan other countries, due primarily to itsbroad economy. In terms of individualcities, Munich and Hamburg were rankedby the report as the top two prospects in2010 for existing portfolios, a rankingthey also held in 2009.
Paris was ranked third by EmergingTrends in terms of prospects for existingportfolios, edging out London in part dueto the general perception that it has awider economic base and is lessdependent than London on the financial
services sector. Interviewees pointed tothe low level of vacancies in Paris,raising its ratings for investmentopportunities and, to a lesser extent,for development. Investor sentimentregarding London ‘improved significantly’from 2009, due primarily to a marketcorrection led by an infusionof funds from the Middle East and Asia.The city ranked fourth in 2010 forinvestment in existing properties and firstfor new acquisition opportunities.For acquisitions, the main focus isoffices, with nearly half the respondentsciting them as the preferred asset type.Despite some scepticism over thelimited extent of the rebound, someinterviewees indicated that they areconfident enough about London to makedevelopment plans for 2011, if not forthis year.
Preferred property types
In terms of property types, the quality ofthe location, building and tenant is themain consideration, according to thereport. City centre offices, high-end highstreet retail and shopping centres are thetop commercial investment choices for2010. Residential investments are alsohighly rated. Although mainstreamproperty types are preferred, nichesectors continue to have some limited
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Emerging Trends in Real Estate Europeappeal, including student housing, selfstorage, retirement homes, socialhousing, healthcare facilities andinfrastructure. Green development of anykind is gaining significance, particularlywith the European Union introducingcompulsory energy efficiency ratings forbuildings. ‘It should become part of theDNA of our businesses,’ said onerespondent.
The overall sentiment is that more equityis available but it is primarily looking fora lower investments: ‘plain-vanilla realestate investments that everybodyunderstands’, core and core-plus, “high-quality assets, already rented to verygood tenants and based in the bestcentral locations” in “the deeper, liquidmarkets: the UK., France, and Germany.”All this means that there is, in practice,lots of money chasing the same relativelysmall pool of top-quality assets.
Launch and panel discussions
The report was launched at the UrbanLand Institute annual conference in Parisat the start of February. This wasfollowed by presentations and paneldiscussions across Europe. For the
London launch, the panel consisted ofBill Hughes, Managing Director, Legaland General Property; Pete Reilly,Managing Director and Chief InvestmentOfficer, Real Estate Europe, JP MorganAsset Management; Michael Acratopulo,Head of Origination, Eurohypo AG andRonan Fox, Managing Director, Standard& Poor’s. As with the presentationsacross Europe, the key concerns werethe broad state of the economy and thelooming refinancing gap. Thepresentations and panel discussionsculminated with a final session at MIPIMat which our panellists were BerndKnobloch, Non Executive Director,Palatium Investment Management;Pere Vinolas, CEO, Inmobiliara Colonialand Carla Giannini, Managing Director,Credit Suisse.
Financial reporting updateIn March we held a webcast tohighlight changes to the reportinglandscape and the potentialimpact on financial reporting.
As the reporting environment iscontinually shifting, the brief webcastcovered a number of topics:
• Cost or fair value – investmentproperty under construction: propertybeing developed to be used asinvestment property once theconstruction is complete is accountedfor under International AccountingStandard (IAS) 40 rather than IAS 16.If all investment property is fair valuedthen property under construction to beused as investment property isrequired to be fair valued.
• Revenue recognition – sale orconstruction contract: the accountingfor property developments undercontracts and whether they can beaccounted for under constructioncontracts (IAS 11) or revenue (IAS 18).
• A new obligation for lessees: asdiscussed in the previous edition ofUK real estate insights, althoughinvestment property lessors havebeen tentatively let off the hook foraccounting for operating leases asfinance leases, under the currentproposals lessees will need to reflectan obligation for operating leases.
• The end of UK Generally AcceptedAccountancy Principles (GAAP):current proposals for InternationalFinancial Reporting Standards (IFRS)for small and medium-sized entities
(SMEs) may have far-reaching effects,given that there are differencesbetween this, UK GAAP and IFRS forother entities. The AccountingStandards Board (ASB) has receivedcomments from respondents to theproposed policy and this will lead tochanges in the current proposals.
• A focus on regulation: commercialproperty remains a Financial ReportingReview Panel (FRRP) focus for2010/11. The webcast also includedan update on the status of Alternative
Investment Fund Managers Directive,a subject covered elsewhere in thisedition of UK real estate insights.
• Top reporting tips: a short summary ofreporting tips for the Annual Reportsand financial statements.
Click here to access the webcast.
Sandra Dowling is a partner and leadsour real estate assurance practice.
Going GlobalAt MIPIM we launched ‘GoingGlobal 2010 - Tax and legalaspects of real estate investmentsaround the globe’, our informationtool developed to provideguidance on the tax and legalaspects of real estate investmentsin countries around the world.
With the impact of the credit crunch,and the knock on challenges this haspresented, these are interesting times forall areas of financial services, especiallythe real estate industry. In this edition wehave brought together investment advicefrom 70 countries, to help our clientsthink about the factors they might facein their real estate investments aroundthe world.
For the first time this year, anonline version of the CD contentshas been made available viapwc.com/goingglobal
Luxembourg Real Estate VehiclesPwC Luxembourg have releasedthe 2010 copy of “LuxembourgReal Estate Vehicles”.
This useful handbook combines valuableinformation on current legal and taxaspects of Luxembourg regulated andunregulated fund vehicles, highlightsfuture developments such as the EUAlternative Investment Fund ManagersDirective, and provides helpful advice onselecting service providers for real estatevehicles and setting up fund structures.
Save the datePricewaterhouseCoopers UK Real Estate Conference 2010
Our annual UK Real Estate Client Conference will take place on the afternoon of Thursday 17th Junein London.
The conference will include thought-leading plenary and break-out sessions covering current issues for the real estate industry.
This will be followed by a series of break-out sessions led by experts from PricewaterhouseCoopers and designed to provideyou with relevant and informative solutions to the challenges you face in this difficult environment for real estate.
Invitations will be sent out shortly.
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Our Real estate insight series Click on the covers below to launch the other editions in our Real estate insight series.
German Real Estate InsightsAusgabe 2 – Februar 2010
Immobilienbranche profitiert vom Wachstums- beschleunigungsgesetz ..................................................................... 3
Grunderwerbsteuerliche Konzernklausel: neue Restrukturierungsstrategien .............................................................. 6
Grundsteuererlass: Handlungsbedarf bis Ende März 2010? ............ 8
Update zur AIFM-Richtlinie ............................................................. 10
Prospekthaftungsrisiken aus Prognoserechnungen geschlossener Fonds ...................................................................... 14
„Green Lease“: vertragliche Sicherung der Nachhaltigkeit ............. 16
Investitionsboom in Wohnimmobilien: Chancen und Risiken ......... 19
Immobilien im Bau: Erweiterung des Anwendungsbereichs von IAS 40 ....................................................................................... 21
Immobilienkäufe im aktuellen wirtschaftlichen Umfeld ................... 23
Benelux real estate insightsIssue 1 – November 2009
02 Introduction
03 Economic views
06 The day after tomorrow – a shortperspective on the financial crisis
09 Belgian and Dutch REIT goingcross-border in the light of theEuropean fundamental freedoms
12 European Alternative Investment FundManager’s (AIFM) Directive
14 Fraud within Real Estate companies –lessons (to be) learned
PricewaterhouseCoopers provides industry-focused assurance, tax, and advisory services to build public trust and enhance value for its clients and their stakeholders. More than 155,000 people in 153 countriesacross our network share their thinking, experience and solutions to develop fresh perspectives and practical advice.
This report is produced by experts in their particular field at PricewaterhouseCoopers, to review important issues affecting the financial services industry. It has been prepared for general guidance on matters ofinterest only, and is not intended to provide specific advice on any matter, nor is it intended to be comprehensive. No representation or warranty (express or implied) is given as to the accuracy or completeness of theinformation contained in this publication, and, to the extent permitted by law, PricewaterhouseCoopers firms do not accept or assume any liability, responsibility or duty of care for any consequences of you or anyoneelse acting, or refraining to act, in reliance on the information contained in this publication or for any decision based on it. If specific advice is required, or if you wish to receive further information on any mattersreferred to in this paper, please speak with your usual contact at PricewaterhouseCoopers or those listed in this publication.
