REITs have been a feature of the UK property market for almost 20 years. However, major tax changes to their operation and qualification in 2022, followed by some more technical but important reforms in 2024, have made private REITs more accessible and attractive to institutional investors.

The 2022 reforms removed the requirement for a REIT to be listed on a stock exchange where institutional investors held at least 70% of its shares, paving the way for the growth of private REITs. The 2024 reforms expanded the regime’s accessibility by relaxing aspects of the ownership rules for funds and partnership structures and aligning certain provisions with wider UK tax legislation.

At the same time, persistent discounts between public REIT share prices and asset values have helped drive a wave of public-to-private deals. For many investors, private REITs now offer an opportunity to combine tax efficiency with greater operational flexibility, helping to drive a fundamental shift in how UK real estate is owned and financed.

S&W partner Matthew Roach tells Property Week about the advantages for developers and owners of investing via private REITs.

What role do private REITs have in the UK market for capital raising and transactions?

There are two key overarching themes: the first is that there has been significant organic growth in the volume of property managed within private REIT structures; the second is that recent mergers and acquisitions (M&A)activity has led to a number of listed REITs being taken private, but retaining REIT status.

Most private REITs are controlled by large institutional investors. By and large, every significant private equity real estate (PERE) house, including Blackstone, Brookfield, Greystar and Starwood, have one in their portfolio. They are not using those vehicles to raise new capital, but are using them when they have a pool of capital in co-mingled funds and wish to invest in a tax-efficient way.

It has become increasingly common for listed REITs to be taken over, retain their REIT status, but become private. A good example is when Blackstone took over St Modwen Logistics and Industrials REIT and merged them into Indurent, while Blackstone took a similar approach with Warehouse REIT. Starwood has also acquired several REITs in recent years, including RDI and Balanced Commercial Property Trust.

While larger REITs are typically London Stock Exchange listed, previously a number of other REITs would meet the qualifying conditions by virtue of a technical listing on The International Stock Exchange (TISE) in the Channel Islands. This provided little, if any, liquidity in the shares, but was solely used to meet HMRC’s REIT status requirements. The relaxation of the listing condition to allow a REIT to qualify where it is 70% owned by institutional investors means it is no longer necessary to maintain a technical listing, which is a major administrative benefit.

What are the pros and cons of private REITs versus traditional UK real estate investment vehicles, such as Jersey Property Unit Trusts?

REITs have several benefits for corporate M&A deals. Typically, where there is a corporate real estate disposal, buyers and sellers share any latent capital gains tax discount, being the 25% UK corporation tax accrued on unrealised capital gains within the company.

Under REIT legislation, for tax purposes, there is a step up to market value in the base cost of the property held by the company being acquired. This is really attractive, as it removes the need for a discount for latent capital gains tax. If you buy an old asset with a lot of built-in capital gains that have not been crystallised, suddenly the REIT comes in; it can pay full value for the asset and effectively eliminate the latent corporation tax discount through the market value rebasing rules.

The REIT has a competitive advantage in that it can pay a higher price for assets. Similarly, on exit, a purchaser who acquires a company out of a REIT group gets the same benefit as, again, there is a market value rebasing of the asset when the firm exits the REIT regime. This means any capital gains accrued during the REIT’s ownership are ignored for tax purposes.

The other advantage is lower tax rates on rental income. REITs were designed to be a pooled vehicle, which is attractive to both taxable and tax-exempt investors. To achieve this, there is generally no tax leakage in the REIT for the property rental business, but there is a 20% withholding tax charge on property income distributions to investors. The withholding tax charge depends on whether the investor is an individual or institution. That allows you to optimise the tax profile of the REIT to accommodate different investor types.

M&A move: UK REITs’ discounts to NAV make more deals like Prologis’s bid for SEGRO likely

Most institutional investors, such as UK pension funds, are entitled to gross payment from the REIT without withholding tax. For foreign corporate investors, the withholding tax rate under most tax treaties falls to 15%.

A non-resident investor owning UK property in a corporate structure will incur 25% UK corporation tax on income and gains. But investing via a REIT has a tax advantage for certain foreign investors, often around 10%, depending on their jurisdiction and applicable treaty position.

That has led international capital, particularly newer entrants from Hong Kong and Singapore, to set up private REITs to take advantage of the lower effective tax rate.

There are some cons, the biggest being that REITs are difficult for development structures, because if you develop an asset, legislation requires the property to be held for three years after completion to benefit from the REIT regime. So, REIT structures are most appropriate for develop-to-hold, not develop-to-sell, strategies.

The requirement to distribute 90% of profits per year can also make it harder to reinvest into operations or new builds. It is possible to manage that by paying scrip dividends or having a dividend reinvestment plan, but it is an administrative hassle.

The other con is a leverage restriction of a 1.25x interest cover ratio, and failure to adhere to this can trigger a tax charge on the excess financing costs. Typical public REIT leverage levels are 30% to 35%, with slightly higher levels for private REITs. But the limits on higher leverage don’t necessarily facilitate the higher returns some opportunistic investors want.

Is there a role for REITs to invest in the growing market for operational real estate, such as the living sector?

The UK public REIT market has been dominated by the British Lands, Landsecs and SEGROs of this world, which are mostly commercial or industrial, with fewer focused on operational real estate. One of the main reasons for this was because many operational real estate structures, such as hotels, generated trading income not rental income, so did not qualify under REIT legislation, which requires a REIT to derive 75% of its income from renting property.

However, a number of REITs have now been set up with a focus on the living sector (including the private rented sector, student accommodation etc) and have been able to manage this issue through more flexible tax structuring, typically by having the property-owning entities within the REIT group, with an operator that sits outside the REIT group. We expect this trend to continue, as there is now a well-established route to hold operational real estate in REIT structures.

What impacts do public REITs’ net asset value (NAV) discounts and recent takeover activity have on the public/private REIT market, and what is likely to drive future takeovers?

Prologis’s bid for SEGRO touches on the interaction of private and public markets. In recent years, public REITs have traded at a typical discount of around 20% to 25%, with a 17.5% 10-year average discount across the sector.

Before the takeover approach, SEGRO’s share price had traded at around a 25% NAV discount for some time. Given current NAV discounts across the sector, it is inevitable that some investors may see takeover activity as the most likely way to achieve full value for their assets.

Combined with recent exchange rates, further public REIT takeovers are likely over the next 12 months, particularly from US investors. It will either be from public REITs like Prologis, or we are going to see another wave of US dollar-denominated PERE funds buying public REITs. In the past, they would have had to maintain the public listing (even only a technical TISE listing), but now, they can take it over, de-list it and keep the same tax structure and benefits.

The costs of maintaining a public listing and other associated issues mean there is also a drive to consolidate in the market, to get the advantages of a bigger platform. This has led to significant merger activity in the past few years, with PHP/Assura just one recent example – a trend that is expected to continue. We can also expect PERE funds to try and spoil the party with opportunistic bids when REIT mergers are mooted.