The Real Estate Investment Trust (REIT) Law and the Philippine Property Market

Almost a decade after being signed into law, Republic Act No. 9856 – also known as The Real Estate Investment Trust (REIT) Law of 2009 – is targeted to be implemented in the first half of 2019. This news comes on the heels of the Bureau of Internal Revenue’s (BIR) RR 13-2018, which confirms that the initial transfer of real property to REITs are indeed exempt from the value-added tax (VAT) as provided by the Tax Reform for Acceleration and Inclusion (TRAIN) Act of 2018. In addition, there have also been ongoing talks between the Securities and Exchange Commission (SEC), Philippine Stock Exchange (PSE), and Department of Finance (DoF) to lower the minimum public float requirement for REITs – from a range of 40% to 67% under the current SEC implementing guidelines to a more manageable 33%. Prior to these developments, major real estate players in the country were hesitant to establish REITs due to the strict tax and legal restrictions.

Real Estate Investment Trusts (REIT)
An REIT is a special type of publicly listed corporation, which purchases, develops, and operates income-generating real estate assets — such as offices, hotels, apartment buildings, and malls among others. It has two key features, as provided by RA 9856, which theoretically make it an attractive investment vehicle: (1) Minimum dividend requirements and (2) Tax incentives.

First, REITs are legally required to declare as dividends 90% of its distributable net income for the year. Through this provision, shareholders of the trust are, essentially, exposed to virtually all of the cash flows from the real estate assets managed by the company. Therefore, REITs can serve as an attractive alternative mode of investing in real estate for investors with minimal capital.

Second, REITs are allowed to claim the dividends it declared and distributed in the year as a deductible expense for income tax purposes. Since the entity is legally required to distribute at least 90% of its realized income per year, it is as if only 10% of its annual net income is subject to the regular corporate income tax rate of 30% — leading to an effective tax rate of around 3% or less. Therefore, major real estate players in the Philippines can theoretically reduce their tax burden by establishing and operating their own REITs.

Through the key features provided by the REIT Law, the government aims to incentivize and stimulate private investment in the Philippine real estate market.

Past Barriers
However — despite the incentives provided by the law, the prominent real estate companies in the country have still been reluctant to establish their own REITs due to concerns regarding value-added tax and minimum float requirements.

The value-added tax levied on the initial transfer of property to REITs increases the cost of organizing the trust. When an REIT is incorporated, the parent corporation would most likely transfer several real estate assets to the trust in exchange for shares of stock. Unfortunately, the 1997 National Internal Revenue Code (NIRC) of the Philippines treats this transaction as a sale of ordinary goods, which is subject to the 12% output VAT. This tax is a major deterrent to real estate firms as the VAT essentially increases the cost of organizing an REIT.

On the other hand, the stringent minimum float requirements remove the control of the parent corporation over the decision making process of the trust. Under the current SEC implementing rules and regulations (IRR), the minimum public float requirement for these companies is set at 40% on the first year of operations. The limit would then increase to around 67% by the end of the third fiscal year. This provision is detrimental to the initial parent corporation as the parent would essentially lose control over the REIT just after the third year.

The major real estate companies believe that these negatives offset, or even outweigh, any benefits provided by RA 9856. Thus — even after 10 long years, no REIT has yet to be established in the Philippines.

Recent Developments
The following developments in the past 12 months, however, have begun to change the negative sentiment.

For one, the Tax Reform for Acceleration and Inclusion (TRAIN) Act of 2018 provided a value-added tax exemption for the transfer of ordinary real properties. The BIR, through its RR 13-2018, further confirmed that this exemption also applies to the initial transfer of income generating real estate assets by the parent corporation to the trusts.

In addition, the House of Representatives of the Philippines issued House Resolution No. 2057 — urging the SEC to revise the IRR with regard to the minimum public float requirement of REITs. As a result, the SEC, PSE, DoF, and other stakeholders have already agreed to reduce the minimum float requirement to a more reasonable 33%. In exchange, the DoF wants safeguards to ensure that whatever capital would be raised by an REIT through its initial public offering (IPO) would only be invested within the Philippines.

The major property companies in the country – such as Megaworld, Double Dragon, SM Prime Holdings, and Ayala Land – are all looking forward to these recent developments.
In fact, Ayala Land Inc. is already planning to establish the first ever Real Estate Investment Trust in the Philippines. Just this April 24, the company has filed an REIT registration with the Securities and Exchange Commission. Once the registration is finalized, Ayala hopes to raise up to $500 Million or around ₱26 Billion through the trust’s initial public offering. With the first domino falling, it would not be long before the other real estate companies follow suit.

A fully-functional REIT market in the Philippines would allow the big players to raise up more capital to further invest in and develop their land bank in the Philippines. In addition, these players also stand to benefit from the tax incentives enjoyed by this new investment vehicle. All of these would mean more capital flowing through the country’s property markets. Thus, should the law finally be implemented in the latter half of 2019, it will serve as a much needed catalyst for the Philippine real estate industry after a sluggish 2018.