On 30 July the Securities and Futures Commission issued its final code on the establishment and marketing of Real Estate Investment Trusts (REITs) in Hong Kong. This marks the end of the consultation process that began in March with the SFC's consultation paper setting out its draft code and inviting comments
Previously the SFC would not authorise unit trusts or other mutual funds that invested in real estate. This meant that REITs could not be offered to retail investors in Hong Kong
Now the SFC will authorise REITs in Hong Kong provided that they comply with the SFC's code, and REITs authorised by the SFC will be eligible to be marketed to retail investors in Hong Kong.
Note the following points on the SFC's code:
- Trusts
- REITs must be constituted as trusts - certain other jurisdictions also permit REITs to have corporate form, but that is not permitted by the SFC's code
- Tax
- In its draft code the SFC proposed that REITs should hold their property investments directly and be subject to Hong Kong property tax. In response to public comment, the SFC's code has now been changed to allow REITs to hold their property assets through special purpose companies (SPVs), which may be incorporated in Hong Kong or overseas. (Most property companies in Hong Kong hold their properties through SPVs - with a separate SPV for each separate property.) This will result in the REIT (through its property holding SPVs) being subject to Hong Kong profits tax - currently at the rate of 17.5 per cent - rather than property tax. This is a beneficial change as the tax deductions allowed for Hong Kong profits tax are more generous than those for property tax
- Stamp duty
- If the properties themselves are transferred into the REIT, the transfer will attract a heavy stamp duty charge of 3.75 per cent of the purchase consideration. To avoid this it will be necessary for the REIT to acquire its property assets by buying the shares in the property owning SPVs which will hold the properties. Hong Kong stamp duty on transfers of shares is charged at a much lower rate - 0.2 per cent where the SPV whose shares are transferred is incorporated in Hong Kong and nil where the SPV whose shares are transferred is incorporated outside Hong Kong and maintains its share register outside Hong Kong
- Listing
- The SFC code now requires that all REITs authorised by the SFC must be listed on the Hong Kong Stock Exchange (HKSE). The SFC is working with the HKSE to draw up listing rules to govern the listing of Hong Kong REITs
- Geographical spread
- The SFC's draft code proposed that HK REITs should only be permitted to invest in real estate located in Hong Kong. Despite much comment requesting the SFC to relax this requirement, the SFC has maintained it in its final code. Accordingly REITs containing property located outside Hong Kong will not be approved by the SFC in Hong Kong. The SFC has said that it will closely monitor how the REIT market develops and will keep its code under review to assess if and when Hong Kong REITs should be able to invest in overseas properties
- Borrowing limit
- The SFC has raised its proposed borrowing limit for Hong Kong REITs to 35 per cent of the REIT's gross asset value
- Dividend payout
- The SFC has slightly relaxed its rules on what percentage of a REIT's profits must be paid out by way of dividend to unitholders. The SFC's code now provides that the minimum dividend payment in any one financial year shall not be less than 90 per cent of the REIT's net after tax income for that financial year
- Types of properties
- In its draft code the SFC proposed that real estate such as hotels or car parks which do not generate recurrent rental income should be excluded from Hong Kong REITs. It has now altered its stance somewhat and the final code states that hotels, recreation parks and serviced apartments are to be included as permissible investments for Hong Kong REITs
- Dividend forecast
- The SFC's draft code prohibited any form of dividend forecast in the offering material for a Hong Kong REIT
The SFC has now changed its mind on this point and the final code permits dividend forecasts provided that they are made on reasonable grounds and supported by a formal profit forecast. The forecast should set out the principal assumptions on which it is based, which must be reviewed and reported on by the REIT's auditor. In addition the forecast as to rental income must be examined and reported on by the REIT's valuer
In summary the final form of the SFC's code contains a number of amendments to the March draft which are likely to assist in the development of the Hong Kong REIT market
The SFC's code will become effective upon publication in the Hong Kong Government Gazette. This is expected to occur soon and the SFC will now accept applications for authorisations under the code. It will be interesting to see how the Hong Kong REIT market develops now that the legal framework for authorisation of Hong Kong REITs is in place
One of the first entities to use the new code could be the Hong Kong government itself. According to press reports, the Hong Kong Housing Authority is considering disposing of part of its property portfolio by injecting it into a corporate vehicle whose shares would then be offered to the public and listed on the HKSE. A REIT might be an alternative. Note also that REITs authorised by the SFC will be eligible for Mandatory Provident Fund (MPF) investment, provided they are also authorised by the MPF Authority
We are actively involved in a number of REIT projects, including the Cheung Kong sponsored Fortune REIT proposed to be listed on the Singapore Stock Exchange.
Clive Rough and Patrick Lines are partners in the Hong Kong office of Freshfields Bruckhaus Deringer.
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