The perennial issues of the illiquidity of property relative to other asset classes and high transactional costs has led, over the years, to a number of innovative structures, through which property investments are held and traded.
In addition to the industry’s long, hard lobbying for the introduction of a UK real estate investment trust (Reit) and various attempts to set up a derivatives market to tackle some of the issues, other solutions have been adopted by a significant number of UK investors.
Until the mid-1990s, there was a trend for property investment companies to operate offshore. The fashion waned for a number of years as UK limited partnerships came into vogue. However, the imposition of a charge to Stamp Duty Land Tax (SDLT) on the transfer of UK land to and from partnerships was introduced by the Finance Act 2004, and this has made these vehicles far less attractive to investors.
Retro fashion has been the plague of the noughties. And so, in the case of property investment, the last 18 months or so has seen a weight of money heading back to offshore destinations such as Jersey, Guernsey and the Isle of Man, predominantly into offshore property unit trusts (Oputs). The private nature of many of these trusts means that figures are not readily available, although it is reported that more than £100bn is vested in Jersey regulated funds alone (of which £12.3bn relates to property). But this does not reflect the private funds which account for a large number of property holdings.
Basic structure
Using Jersey as an example, the basic structure of an Oput is as follows:
Legal ownership of the asset will become vested in a trustee or trustees, or jointly by a trustee and nominee for overreaching purposes.
The trustee(s) will hold the asset on trust for the benefit of the holders of units in the Oput.
There is no requirement to appoint a trustee independent of the manager of a private unit trust and therefore running costs can be kept to a minimum.
The Oput itself will be managed and administered by a manager, who may be the trustee, although this function can be split.
The trustee (or manager) will appoint a property manager to carry out the usual property management functions, such as rent collection.
The Oput will be regulated by a trust instrument that is similar in nature to the articles of association of a company.
Trust laws relating to the relevant jurisdiction will govern the precise nature of the trust created.
As with shareholdings, a register of unitholders is kept and unit certificates may be issued.
Units are generally priced at net asset value.
The manager will charge a fee for managing the Oput.
Some of the considerations to be borne in mind when considering an Oput include:
Improved liquidity
Instead of trading the property, the units in the Oput may be transferred. In practical terms, the trustee (and manager, if appointed) will approve the transfer on receipt of a unit transfer instrument (and any other documents required under the trust deed) and on satisfaction of due diligence relating to the new investor.
Alternatively, units may generally be redeemed on giving notice to the manager. The manager may impose waiting periods if the demand to redeem exceeds the liquid funds available at any time.
In either case, units may be sold in small lot sizes and generally without incurring VAT or SDLT. The smaller lot size increases liquidity.
Nevertheless, for private funds, incoming investors are still likely to require full property due diligence, as mentioned below.
Lower transaction costs and speed
The costs of initial set-up and the ongoing administration of an Oput will have to be factored in by investors and these will vary depending on the chosen jurisdiction.
However, the return to favour of the Channel Islands in particular is, in part, owing to the recent introduction of a faster and more flexible regulatory environment, which allows investment funds satisfying certain criteria to be authorised quickly and inexpensively. Furthermore, where property assets are transferred to the trustee at the time of set-up and the Oput is a collective investment scheme (which by definition requires more than one investor), in certain circumstances the initial set-up costs can be offset by a saving of SDLT.
Time-zone, infrastructure and ease of access will be further factors in choosing the appropriate jurisdiction in which to set up an Oput, which also favour the Channel Islands and the Isle of Man. On the flip-side, the fund must be managed and controlled offshore (and this includes holding board meetings) to enable investors to benefit from exemption from capital gains tax (CGT).
As to speed, it is important to remember to include in the transaction timetable the production of additional documentation and obtain input from advisers situated in the chosen jurisdiction and (on its establishment) regulatory approval of the Oput.
After the initial set-up, buying units in an Oput is analogous to buying shares in a private property company. However, to purchase a private property company, all the usual property due diligence (whether by production of certificates of title or otherwise) must be undertaken, plus company due diligence. Before a new investor can acquire units in an Oput, the trustee must carry out investor due diligence for anti-money laundering purposes and a level of due diligence will be undertaken in relation to the setting up of the trust, although this is a lesser burden than the due diligence required to purchase shares in private companies.
These additional layers of due diligence lend neither speed nor a saving of professional fees to the investor when compared with direct investment in property.
Diversification
Oputs will generally invest in a diverse range of products. In addition, investors can gain exposure to different sectors and larger-sized property assets by holding units in a number of different funds, in each case without assuming the direct burden of property management.
Tax transparency
The original popularity of limited partnerships owed much to the tax transparency of the structure. That is, the partners in the limited partnership received the same tax treatment as they would have received by holding as a direct investor. Therefore, pension funds, for example, could participate without losing their beneficial tax status.
Oputs offer a similar advantage to the unitholders and will generally be structured as a ‘Baker Trust’. A Baker Trust is transparent for income tax purposes but opaque for the purposes of capital gains tax. In practice, this means each unitholder is subject to tax on their share of income, less expenses. UK residents may receive the rental income gross. Generally, non-UK residents will receive net rental income after the deduction of basic rate tax (currently at 22 per cent).
Where an Oput disposes of property, no capital gains tax will arise because the gain will accrue to the Oput (and not the unitholders) and the Oput will be outside the scope of UK capital gains tax because it will not be resident in the UK for tax purposes.
On the disposal of units, UK resident unitholders will be subject to capital gains tax on any gain arising. In calculating the gain, taper relief on indexation will be available.
Impact of Reits
Time will tell how big the impact of a UK Reit will be on the trend to move investments offshore. Oputs and Reits bear some similarities (both vehicles are/will be tax transparent and both are intended to promote diversification of investment). But the two products are likely to coexist as alternative investment vehicles. Reits will not have the added burden of offshore administration. However, Oputs enjoy a more advantageous SDLT (and quite probably CGT) position than those proposed for Reits. Also, Oputs can offer greater flexibility in terms of their ability to borrow and to carry out development than is currently proposed for Reits.
In conclusion, while Oputs have seen a surge in popularity of late, they are not a panacea for all the ills of direct property investment in the UK. They do, though, have a number of qualities which should see them remain part of the landscape of investment in UK property for some time
to come.
Gill McGreevy is a consultant and Kevin Ashman a partner at Lovells
