2023.04 The Taiwan Banker NO.160 / By Su Weihua
New dual structure will make REIT operations more flexibleBanker's Digest
In order to provide investors with more diverse investment channels, increase the competitiveness of the asset management industry, and activate Taiwan’s real estate securitization market, thereby increasing the stability and efficiency of the financial system, the FSC has amended the law on management of real estate investment trusts (REITs). Accordingly, the Taiwan Banker has specially invited Sam Chang, Director General of the FSC Securities and Futures Bureau, to explain the biggest changes of the amendments and the benefits of the changes. Real estate sellers are uninterested in securitization On July 23, 2003, the Real Estate Securitization Act became effective, which provided a legal foundation for the trust industry to engage in real estate securitization. Real estate had been struggling for some time when the legislation first passed, and commercial real estate was faltering as well. Owners were more willing to securitize their real estate, and eight REITs were set-up from 2005-2007. Director General Chang explained that commercial real estate prices in major cities have grown substantially since 2007. Sellers are generally able to quickly dispose of properties directly, and are therefore uninterested in securitization. Rent has however not grown to the same degree as sales prices, which has made it difficult for investors to find suitable returns, which has caused both the issuance and expansion of REITs to nearly collapse. Between 2015-2023, three REITs entered liquidation, leaving only seven of the ten REITs that began operation over the last eighteen years continuing to operate, with a combined market value of approximately NT $105 billion. The FSC has continued to review relevant laws and regulations. Between 2015 and 2019, it amended the law and issued an order to simplify public offerings for trust-structured REITs, relaxing investment limits as well as the scope of investment targets. However, the past year’s combination of high real estate prices and low rents has made it hard for trustees to find domestic investment targets with suitable returns. Due to the low earnings on rent, returns are only about 2.5%. Moreover, not only does the management decision-making power rest with the trusts, which operate in a conservative fashion, but the current tax system does little to incentivize merging of funds, all of which has led to a bottleneck in market development. Existing REIT markets in Asia While Japan and Singapore began development of their REIT markets around the same time as Taiwan, the two nations have become leading REIT markets in Asia. Japan currently has 61 REITs in operation, with a combined market value of approximately NT $4.1 trillion, and a return rate of approximately 4%. Meanwhile, Singapore boasts 44 REITs, with a combined market value of approximately NT $2.5 trillion and a rate of approximately 6%. Looking broadly at the factors contributing to the successful development of these markets, the majority of the credit belongs to their uniform adoption of the fund structure, support of promoters, sound corporate governance and disclosure systems, tax incentives, and flexible investment frameworks. Director General Chang attributes the successful development of Singapore’s S-REITs to three key factors. First, issuers are the crux of the success, playing a key role in both whether an S-REIT can be successfully established, and its scope can continue to grow thereafter. S-REITs use external managers, which are typically subsidiaries fully owned by the issuer. This allows the issuer to collect management fees and continue controlling the operations through the manager, which makes it more willing to provide the best returns. Moreover, in addition to promising continued financial support, the issuer normally gives the S-REIT the right of preemption. Thus, when the Monetary Authority of Singapore (MAS) and Singapore Exchange audit newly-established S-REITs, issuer qualifications are a primary point of consideration. S-REITs are thus able to earn issuers continued support and attract foreign and domestic investors, which is the main reason for their successful development. Additionally, when it comes to tax incentives and investment frameworks, Singapore collects no stamp duty or capital gains tax. As long as an S-REIT is able to comply with the 90% distributable income condition, it enjoys tax benefits. Singapore also provides foreign and domestic S-REIT investors with differing tax incentives, such asindividual tax exemptions and tax withholding of only 10% for foreign investors. Singapore does not limit the investment frameworks of S-REITs, providing a flexible investment framework for tax planning and mitigation. The tax benefits and flexible investment frameworks enable tax mitigation, reduce investment costs, increase returns, attract investors to Singapore, and make Singapore the center of REITs in Asia. Finally, Singapore emphasizes corporate governance and information disclosure. It requires S-REIT managers to establish independent boards of directors and accounting committees, encourages establishment of nomination and compensation committees, and also requires the managers to provide written sustainability and corporate governance reports, related-party transaction disclosures, performance fee information, and other important information that may influence the rights of beneficiaries. Moreover, since 2019, MAS has required listed corporations’ independent board members to serve terms of at least nine years in length, and allowed investors to vote on the independence of these board members, strengthening the independence of boards. Thus, sound corporate governance and information disclosure are two main attractions of Singapore. Amending the Investment Trust and Consulting Act Given that Japan and Singapore make use of fund-structured REITs, where the management institutions direct the operations, and they also provide tax benefits, Taiwan will revise the Investment Trust and Consulting Act with reference to regulations in Japan, Singapore, and Hong Kong. Fund-structured REITs will have four major characteristics. First, investment trusts will be able to serve as management institutions, increasing the professionalism of property management. Second, simplifying additional fundraising procedures, guaranteeing the right of preemption and profit support, and allowing for flexible investment frameworks to encourage overseas real estate investment will help ensure stable returns and the continued growth of REIT size. Third, allowing REITs to carry out related-party transactions will help increase the flexibility of asset allocation. Real estate developers are increasingly the primary sources of real estate for REITs in Japan, Singapore, and Hong Kong, which also increasingly belong to the same conglomerates or stakeholders alongside the management institutions. In fund-structured REITs, more methods for related-party transactions will be permitted, increasing the scope of assets available. Finally, separating custodial and managerial responsibilities will help clarify rights and responsibilities. Fund-structured REITs will be managed by real estate investors, while the assets will be managed by investment trust custodians and supervisors, which differs from investment trust-structured REITs, which are both held and managed by an investment trust. Moreover, appointing real estate managers (like construction contractors) to provide investment recommendations will also help to clarify rights and responsibilities. Supporting economic development The principal objective of the REIT structure is to invest in real estate to produce steady income, including properties or related rights that already have a stable income via rent. Moreover, REITs regularly distribute the majority of their income to investors. Office buildings, tourist hotels, department stores, warehouses, data centers, and medical insurance buildings are all investment targets. The goal of social housing, land that falls within the scope of approved urban renewal plans of the Urban Renewal Act or rebuilding plans approved by the Statute for Expediting Reconstruction of Urban Unsafe and Old Buildings, buildings and related rights, infrastructure as defined by the Act for Promotion of Private Participation in Infrastructure Projects and infrastructure approved for participation by the relevant central authorities, and wind and solar power projects is to ensure tenant rights and support major national policy pushes. This is all being done in order to bring about housing justice, promote urban renewal, elevate housing quality and security, and support important national infrastructure. Director General Chang said that through disclosures on whether investment targets conform to the core properties and product characteristics of REITs, we can actively encourage and guide REIT funds to invest in major national policy priorities. Reforms expected this year The revised draft of the Investment Trust Consultant Act was examined by the Executive Yuan’s inspection committee on December 27, 2022, and the latter report to the Executive Yuan. The draft will then be sent to the Legislative Yuan for further deliberation, probably sometime this year. Within six months of the final revision, the FSC will announce changes to the law to differentiate between fund and trust REITs, improving compliance on when issuance of fund-structured REITs. Director General Chang also said that opening REITs up to the fund structure will allow “real estate investment trusts” to raise funds and privately offer REIT funds, which will parallel current trust-structured REITs. In the future, issuers will be able to choose between fund- and trust-structured REITs. We can expect this further flexibility in operating frameworks to boost Taiwan’s capital market and further activate its real estate securities market.