October 15 2010
In the slipstream of the problems experienced by the Belgian, European and global economies, 2010 will be regarded as a year of slow and prudent transition for Belgium's real estate market. After a correction process in 2008 and 2009, the market is showing signs of recovery and the appetite for investment appears to be returning. However, the fall in prices for Belgian real property and the weakness of the office rental market have slowed activity in the real estate financing sector.
A number of wider legal developments have also affected the market or may yet do so. For example, the Act on the Continuity of Enterprises entered into force on April 1 2009, introducing a reorganisation process comparable to a US Chapter 11 procedure. The innovation has generally been seen as a success and the real estate market will be increasingly faced with companies applying for the act's safeguarding procedures.
However, one of the most significant developments for commercial property financing relates to proposed changes to the regulation of real estate investment trusts (REITs).
For tax purposes, alternative financing for real estate investments can be obtained through undertakings for collective investment, which are comparable to US REITs. A real estate BEVAK or SICAFI(1) - a Belgian REIT - is a closed-ended real estate fund with a fixed number of shares. Its object is to use the capital that it raises through a public issue for direct or indirect investment in real estate. REITs are strictly regulated by law. They are almost completely exempt from corporate taxes, but only on strict conditions. For instance, their shares must be listed and traded on an exchange and the property risk must be spread: REITs cannot invest more than 20% of their assets in a single building or site.
Belgian REITs have been active on the financial and real estate markets in 2009 and 2010 in order to diversify and restructure their portfolios, but also in order to remain within the legal debt ratio window, given the decline in the fair market value of their underlying assets.
On the one hand, REITs have been raising capital and issuing bonds in order to purchase property. They have been diversifying their portfolios by acquiring hotels and sheltered or serviced housing for senior citizens. As market prices have fallen, advantageous purchase opportunities have arisen. On the other hand, some REITs are seeking to increase their share capital for legal reasons. A significant reason for REITs seeking to raise capital in today's markets is the combination of rules set forth by the Royal Decree on REITs of April 10 1995 (as amended) and by International Financial Reporting Standards (IFRS).
Some REITs seek to increase their share capital in order to comply with their maximum legal debt ratio (ie, the ratio of total debts to total assets). One of the most important rules in the decree is that a REIT's debt level may not exceed 65% of the value of its assets (in practice, banks may require an even lower maximum figure).
However, as the value of the typical REIT's asset portfolio fell in 2008 and 2009, its debt ratio increased. Market analysts predict that REITs will have to make additional efforts to avoid losing tenants. An increased vacancy level and a loss of rental income would only further depress asset valuation levels.
Moreover, throughout 2010 the falling long-term interest rate has been hurting REITs that had concluded significant interest rate swaps or other derivatives to hedge their exposure to interest rate fluctuations. Such derivatives may protect the REIT by capping the maximum interest rate payable, but they sacrifice the profitability of a drop in interest rates. As rates have been falling over the course of 2010, the cost of such derivatives has been high and the value of the derivatives has dropped accordingly.
In accordance with IFRS, both the asset portfolio and any interest rate derivatives must be booked at market value; in today's market, this further increases the debt ratio.
Although the decree sets a maximum debt ratio of 65%, another provision of the decree states that in order to be virtually exempt from corporate taxation, REITs must distribute at least 80% of their net profits to their shareholders. Given the position of the markets and the IFRS requirements - that is, the falling value of the asset portfolio and interest rate derivatives, which must be booked at market value - this high profit distribution level can make it extremely difficult for REITs to respect the maximum debt ratio of 65% without increasing their share capital.
In addition, the 80% requirement may conflict with the Companies Code, which provides that a company (including a REIT) cannot distribute a dividend to its shareholders if its net assets have fallen below the share capital (or would do so as a consequence of the distribution), which is the case for some REITs.
In this complex legal situation, REITs sometimes reduce their share capital in order to be able to distribute dividends to their shareholders.
In order to resolve the confusion, which has been aggravated by the financial crisis, Belgian REITs have been lobbying for structural reform. In February 2010 the federal government held an open consultation on a draft decree to replace the 1995 decree.
The draft decree establishes a more flexible procedure for raising capital. It allows REITs to distribute dividends - up to 80% of their net profits - not only in cash, but also in shares. REITs have also lobbied for an exemption from the legal requirement to respect the pre-emption rights of existing shareholders in the event of a capital increase by cash contribution. At present, REITs cannot limit the pre-emption rights of existing shareholders, whereas other companies can.
The draft decree also proposes an interesting new kind of REIT, termed an 'institutional REIT'. An institutional REIT can be a 100% subsidiary of a publicly listed REIT, as well as a common subsidiary of a publicly listed REIT and third parties. Such third-party shareholders must be institutional or professional investors, such as pension funds or credit institutions. The institutional REIT must be directly or indirectly controlled by a publicly listed REIT, which must hold 50% or more of the former entity's share capital, either directly or indirectly. If certain conditions are met, the institutional REIT can benefit from the same tax regime as a publicly listed REIT.
Furthermore, the draft decree requires a REIT with a debt level of over 50% to devise a plan to prevent its debt level from exceeding 65%. The plan must be submitted to the Banking Commission. The draft decree also requires REITs to have three independent directors on their boards and introduces new rules to secure the independence of the real estate expert who values the properties owned by the REIT.
Unfortunately for the REIT sector, since the resignation of the federal government in April 2010 and subsequent elections, the legislative process has been put on hold. It is to be hoped that the reform will continue once a new government is in place, as the outgoing government has already fully prepared the draft text of the decree.
For further information on this topic please contact Lieven Peeters, Johan De Bruycker or Bram Delmotte at ALTIUS by telephone (+32 2 426 1414), fax (+32 2 426 2030) or email (email@example.com, firstname.lastname@example.org or
(1) The acronyms derive from the Dutch and French terms for an investment company with a fixed number of shares - 'beleggingsvennootschap met vast kapitaal' and 'société d'investissement à capital fixe'.
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