REIT ASIAPAC
L E G I S L AT I O N
Legislation
A R E R E I T S F I N A L LY
A B O U T TO TA K E
OFF IN THE
P H I L I P P I N E S?
By Charles Isaac,
Founding Partner, B&I Capital
The property transfer tax hurdle appears
to have been cleared, first, the Tax Reform
for Acceleration and Inclusion (TRAIN) 1
tax reform passed in January 2018, which
implied that property could be transferred
tax-free. This was subsequently confirmed
under TRAIN 2 in May 2018 and by the
Bureau of Internal Revenue which stated
that the transfer of property would be
Value-Added-Tax exempt.
Charles Isaac,
Founding Partner, B&I Capital
REIT legislation was passed in the
Philippines ten years ago. However, to-
date no REITs have been launched due to
two major hurdles that developers have
not been willing to accept. Firstly, a 12%
property transfer tax and, secondly, a
67% required Minimum Public Ownership
(MPO).
There has been a flurry of activity in the
last six months with most commentators
expecting these hurdles to be cleared
finally. The latest regulatory move was
on March 22nd when the Philippine Stock
Exchange issued a public consultation
paper on proposed amendments to the
REIT listing rules, suggesting there is
ongoing momentum.
This leaves the MPO as the last major
hurdle, and it looks like it will go away with
the Securities and Exchange Commission
(SEC) suggesting they are looking to
reduce the MPO to 33% from 67% in
the Implementing Rules and Regulations
(IRR).
However, Ayala Land (ALI) announced
on April 24th that they would launch a
US$500 million REIT seeded with Manila
office assets. Interestingly, they said they
are willing to go ahead using the MPO
of 67% and will not necessarily wait for
the revised IRR. If Ayala Land does go
forward with this REIT, we will applaud
the move as it negates some of the risks
and arguments highlighted below. It also
strongly suggests that it realises that the
longer- term benefits of a well-conceived
REIT outweigh the pure focus on tax
optimisation.
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“If Ayala Land does go forward
with this REIT, we will applaud
the move as it negates some
of the risks and arguments
highlighted below. It also
strongly suggests that it
realises that the longer- term
benefits of a well-conceived
REIT outweigh the pure
focus on tax optimisation.”
MPO IS A HURDLE AND
SHOULDN’T BE REQUIRED
Our view is that there should not be an
MPO at all and that sponsors should realise
that it makes sense to reduce their stakes
over time. The oft-mentioned reason for
keeping a high stake is that developers
are worried that there would be a hostile
takeover of the REIT. Either this is a smoke
screen to the real reason, or they have
not grasped exactly how difficult it is to
make a hostile takeover of a REIT, taking
into consideration factors such as the
REIT manager structure, management
contracts, properties managed by a
sponsor, political issues, etcetera.
Cynics might imply that the real reason
to want to keep such a high stake is that
COMPANY PRICE
(PHP) MKT CAP
(USD BN) NAV P / NAV SM PRIME HOLDINGS 38.95 21.55 40.87 0.95 AYALA LAND 45.00 12.69 65.95 0.68 avoidance vehicles will probably trade on
low valuations and therefore have a higher
cost of capital (trade on high yields),
meaning they risk becoming zombie value
traps. We also see examples of this type.
MEGAWORLD 5.68 3.51 10.45 0.54 WHO ARE THE WINNERS?
ROBINSONS LAND 24.25 2.41 40.84 0.59 7.24 1.76 17.86 0.41 22.40 1.02 57.8 0.39 1.50 0.70 4.705 0.32 How to play it? (Disclaimer: we have this
barbell strategy in place). The beneficiaries
and winners from this extended process
are going to be the major developers
with a sufficiently large and stabilised
commercial real estate portfolio such as
Ayala Land, Megaworld and SM Prime.
DoubleDragon is also one to look at.
Ayala Land and Megaworld trades at a
large discount to Net Asset Value (NAV),
so realising some of the NAV will, by
definition, push up the share price even if
it does not re-rate. SM Prime will benefit
primarily from having a cheaper funding
source and a lower cost of capital which
will help fund their future growth, such
as the Manila Bay reclamation project.
DoubleDragon has a pipeline of suitable
properties although we think they need to
be stabilised first and the overall portfolio
expanded further before being ready to
launch a REIT.
VISTA LAND
DOUBLE DRAGON
FILINVEST
Source: Bloomberg, Factset, B&I. 5/4/19
(and unusually under REIT regimes), the
dividend income from REITs to corporates
will not be taxed in the Philippines, so
this is a perpetual windfall for the already
wealthy developers. In other words, there
will be no tax due on rental income at
either the REIT level or at the corporate
holders of the REIT shares level.
The solution that looks like being the
compromise is that developers that
launch REITs will have to reinvest the
proceeds from the REIT in the Philippines
and not overseas. This was evident in the
March 22nd consultation paper issued by
the Philippines Stock Exchange. However,
money is fungible, so if a corporate that
launches a REIT does invest outside the
Philippines, it is inconceivable that the
authorities can prove from where the
money came! Plus, the vast majority of real
estate companies generally invest most of
their funds locally, not internationally, so
why should they start going offshore just
because they have launched a REIT?
RISKS OF A LARGE
MAJORITY SHAREHOLDER
Therefore, it looks like developers will
want to retain the 67% maximum allowed,
assuming the MPO is reduced to 33%. The
problem with this is that if you have such a
large majority holder plus the other stable
long-term holders, such as local pension
funds, that REITs attract, it is unlikely that
there will be enough secondary liquidity
to either attract institutional investors
or to justify a premium valuation. The
risk is that we see an initial squeezing
up in the share price due to the novelty
as well as the low availability of shares.
Ultimately, however, the REIT may trade
at an illiquidity discount and therefore be
unable to grow accretively.
We understand corporates that have
built their wealth around real estate over
generations do not want to lose direct
ownership of their prized properties.
However, if the sole reason to launch a
REIT is the tax benefit to the sponsor or
to offload problem properties, then these
are not REITs in which we will invest
in because they underperform better-
conceived REITs.
“REITs that are launched purely
as tax-avoidance vehicles
will probably trade on low
valuations and therefore have a
higher cost of capital (trade on
high yields), meaning they risk
becoming zombie value traps.”
As we have seen elsewhere, REITs that have
the right structure and are professionally
managed (not managed solely for the
benefit of a sponsor) perform better than
other REITs and lower the cost of capital
for the sponsor as well as the REIT. There
is also built-in discipline and transparency
with the REIT structure which leads to
better focus and performance. This often
seems to come as a surprise to the sponsor
whose head shares perform worse than
their REIT, and we see plenty of examples
of this.
REITs that are launched purely as tax-
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In conclusion (and before Ayala Land’s
announcement to go ahead with a REIT
even with a 67% MPO), the setup that
looks likely to prevail with a 33% MPO
is not a best-in-class solution because
the incentives and multiplier effects that
make REIT regimes such a success at
many levels are out of balance. We hope
we are wrong, but it also appears that the
developer’s focus is more on a one-time
NAV uplift and the perpetual tax benefit,
rather than considering the multiplier
effects and lowered cost of capital that a
well-managed REIT brings.
However, perhaps the best thing is to get
REITs launched in the Philippines, even if
they are imperfect at the start. This has
often been the case elsewhere; it takes
time for the market participants, including
the government, to get comfortable with
REITs and to understand how beneficial
a REIT regime might be. As the market
does get comfortable, the regime can
be tweaked to improve it, and the well-
managed REITs outperform, encouraging
others.