HOW OUR PROPERTY MARKET IS CURRENTLY STRUCTURED
For historical reasons, there are two broad types of property companies in South Africa: the ones that pay corporate tax and the ones that do not.
Within the non-tax paying category, there are PUTs (Property Unit Trusts) and PLSs (Property Loan Stocks), and there are further differences with respect to the tax treatment for these two types of companies.
The PUTs pay neither corporate tax nor CGT (Capital Gains Tax) on disposal of individual property assets. Notwithstanding their favourable tax treatment, PUTs are not governed by the Companies Act and therefore do not have the corporate governance mechanism.
The PLSs are currently governed by the Companies Act and therefore have the governance structure in place. However, while they are also exempt from corporate income tax, they do pay CGT when selling property assets.
What PUTs and PLSs have in common is that they distribute earnings before tax to their investors, which is deemed to be net rental income.
WHAT WILL CHANGE FROM APRIL 2013
The Real Estate Investment Trust (REIT) framework will be an umbrella legislation that will allow PUTs and PLSs some enhanced features which they never had before:
CHANGES FOR THE PUTs:
- They will continue being exempt from both income tax and CGT
- They will have an option to retain their current corporate structure as a trust (i.e. not subject to the Companies Act), or choose to convert to an equity capital structure and be governed by the Companies Act
- They will get the roll-over relief for the first time. This could act as a fillip for PUT to convert to an equity capital structure and be governed by the Companies Act
- They will distribute at least 75% of the earnings before tax. In the past, they had to distribute 100% of the earnings before tax
- They will be exempt from both corporate income tax and CGT
- They will be able to convert from a linked debenture and equity linked unit structure to a simple equity capital structure
- The roll-over relief when doing share-for-share transactions will continue as per usual
- They will distribute at least 75% of the earnings before tax. In the past, they generally distributed about 100% (or marginally below) of the earnings before tax
- There will be no conversion fees or entry tax like we have seen in other countries
CHANGES FOR THE PLSs:
The terms PLS and PUT have often confused investors, particularly offshore investors. The conversion to REIT legislation will result in a uniform structure that will be most welcome.
To list as a REIT, companies need to meet four basic measures:
- A minimum gross holding of property assets of R300 million
- A total debt to total asset ratio of 60%
- 75% minimum income from property rental, as broadly defined
- Distribution of a minimum of 75% of distributable profits
IMPLICATIONS TO THE SA LISTED PROPERTY MARKET
The Real Estate Investment Trust (REIT) legislation has been signed into power and is expected to be implemented in April 2013.
We believe this to be a positive move for the industry. The main benefit of this new legislation will be to align the SA listed property market with the rest of the established property markets while making the tax structure on the different listed property vehicles more transparent, simplified and uniform.
With the enactment of this legislation, South Africa will become the eighth largest REIT market in the world. This is significant, as South Africa’s weighting in the global property indices can be expected to increase substantially. It could quadruple according to Macquarie Research.
As with all index reweightings, we can expect some property shares (units), especially the bigger counters, to re-rate. Most of the South African big counters like Growthpoint and Redefine already have foreign shareholding of between 10% and 15%, but this number can be expected to increase. This will increase demand for our listed property shares, which is a positive for the sector.
Another positive spin-off is that the deferred tax will be removed from balance sheets. This will have the effect of boosting Net Asset Values (NAVs) and therefore reducing the premium that SA listed property is currently trading at. In other words, it will make listed property cheaper relative to its current levels. This will make it more attractive to investors and therefore is likely to boost demand further.
We welcome this new legislation as a positive improvement to our listed property universe.