Will REITs soon be within reach?

Business World (10/7/2019 – p.S1/5)

SUITS THE C-SUITE By Cyril Jasmin B. Valencia

Real Estate Investment Trusts (REITs) had been gaining propulsion globally for many years. Locally however, since the introduction of REITs a decade ago, industry players have yet to launch the first such offering to the public. Recently, there have been positive regulatory developments that are expected to provide an attractive landscape for potential players to proceed. While it is true that there are many opportunities in this field, players must find ways to operate within the regulatory framework, allocate the asset portfolio effectively, comply with governance requirements, and adapt to continuing industry disruption.

THE SPONSOR
The big players in the real estate industry see REITs as an alternative venue for capital raising. It is a platform where Sponsors can unlock the value of their existing properties and receive upfront cash proceeds which can be redeployed to future growth projects. These big players act as Sponsors, who own the assets. They will need to weigh options as to the type of assets, among their portfolio, that can be contributed to the REIT company (REIT Co.), which will in turn operate the asset. A key point for the Sponsor in deciding on which asset to contribute is the asset’s ability to generate steady income since the law requires annual dividend declarations by the REIT Co. It is also equally important for the Sponsor to determine the proper valuation of the asset transferred, to ensure that shares received from the REIT Co. are commensurate to the value of the assets given up.

The Sponsor will have to be prepared for how the transaction will impact its financial reporting, for both the separate and consolidated financial statements given the continuing need for transparency to its stakeholders and compliance with governance requirements. Before the actual transaction, it is important for the Sponsor to simulate the accounting implications in its books, particularly for the transfer of property to the REIT Co. in exchange for cash/shares or other considerations, and the treatment of its investment in REIT Co., on a continuing basis.

It should be noted that in the separate financial statements, if the asset contributed by the Sponsor is other than cash, there is a need to assess how the value of the investment in REIT Co. will be booked, which may result in a gain or loss. Assuming the REIT Co. is controlled by the Sponsor at initial contribution, the transfer is a non-event transaction in the consolidated financial statements reporting.

Under the legal framework, the REIT Co. is required to sell its shares during the initial public offering (IPO) and this will continue in the subsequent three-year period to meet the Minimum Public Ownership (MPO) requirement of 33% to 67%. Given the MPO requirement, there should be a continuing assessment if the Sponsor still has control over the REIT Co., or if such control has been reduced to joint control or significant influence or a simple investment in a financial asset. The accounting for the type of relationship will impact the income reported and balance sheet of the Sponsor.

THE REIT CO.
Given the MPO requirement, the REIT Co. should have a clear plan on the timing of the share offering and the continuing ability to price the shares commensurate to their underlying value.

Another strategic decision for the REIT Co. is to determine the composition of a Fund Manager, who will implement investment strategies, and a Property Manager, who will manage the real estate assets considering the need to sustain the annual earnings. As contained in the law, such earnings will be tax-free to the extent of income that is distributed, but the savings from taxes will have to be escrowed in the meantime with the Bureau of Internal Revenue (BIR) until the MPO requirement is met.

There is a need for a strong backbone to ensure continuing transparency and above-par governance. The REIT Co. will have to consider the financial reporting implications of the accounting for the asset received from the Sponsor; the classification of shares issued; the treatment of dividends; and the treatment of cash escrowed by tax authorities in relation to the MPO requirement.

Furthermore, the relationships of the REIT Co. and the Sponsor with each of the Property Manager and Fund Managers will have to be studied carefully to determine the existence of control, joint control or significant influence, or possible treatment as a financial asset investment.

Any tax implications from the perspective of all parties involved will have to be studied as well in order to ensure that the structure and the contracts are designed in a most tax efficient way.

THE NEED TO BE AGILE
The potential players will have to be cognizant of the continuing disruptive influences that are happening in the REITs space in other parts of the world. REIT assets today can just be in the form of malls, office space and industrial buildings. In the future, they can be assets in alternative sectors, such as data centers, wireline, communication towers, electronic vehicle charging zones, solar canopies, or battery storage, among others. In fact, several REIT jurisdictions have granted REIT status to these alternative property types. These influences may come from changing customer behaviors among space occupants, continuing demand for work and play balance, technological advancements and easing regulatory frameworks. Given these, it is of the utmost for the management to keep an open mind to these changes and be able shift the gears as quickly as needed.

Regulators on the other hand will have to continue paving the way for business-friendly legislation, which can translate to strong job growth, high occupancy and additional tax collections.

There are many moving parts in the REITs web. Hopefully, once the above fundamentals and preparations are put in place, the once blurry and far off horizon for REITs can soon be within reach.

This article is for general information only and is not a substitute for professional advice where the facts and circumstances warrant. The views and opinion expressed above are those of the author and do not necessarily represent the views of SGV & Co.

Cyril Jasmin B. Valencia is the Real Estate Sector Leader and Partner of SGV & Co.