Page 135 - Profile's Unit Trusts and Collective Investments 2021 issue 2

Understanding Asset Allocation

REIT Rules
In order to qualify for the REIT tax dispensation, both Trust REITs and Corporate
REITs must comply with the following rules (amongst others):
Debt not more than 60% of assets
Must obtain at least 75% of income from rentals
Must distribute at least 75% of distributable profits to shareholders or unitholders
May not use derivative instruments except in the ordinary course of business
The amounts paid by REITs are called distributions. They are taxable as income in the hands
of investors. Note that under CISCA, Trust REITS pay out 100% of distributable profits.
A Corporate REIT could choose to retain up to 25% of distributable profits.

REITs and Corporate REITs.) Most Corporate REITs are property-owning entities that were
previously known as Property Loan Stock (PLS) companies.
Nearly all JSE-listed PLS companies now comply with the REIT tax legislation, making them
look very similar, from an investor’s point of view, to listed Trust REITs. They are, however,
different legal entities (ie, companies rather than trusts). The number of trust REITs has declined
over the years with the advent of corporate REITs: Capital was acquired by Fortress, Fountainhead
was acquired by Redefine, and SA Corp converted to a Corporate REIT. There is currently only one
trust REIT (or CIS REIT) listed on the JSE, the Oasis Crescent Property Fund, listed on Alt-X (the
Liberty Two Degrees trust REIT converted to a corporate REIT in October 2018). Note that
Corporate REITs are not collective investment schemes.
Due to their structure, REITs offer significantly higher yields than other equities. In general,
the yields of REITs compete with general retail interest rates in the market. Prices of these shares,
however, which are listed on the stock exchange, are subject to demand and supply pressures and
vary each day, and so capital gains or losses have to be taken into account. Also, unlike equity
dividends, the income from REITs is fully taxable (ie, it is treated as interest).
As most UTREFs invest predominantly in listed REITs, the income profiles and tax
consequences of REITs flow through to investors buying open-ended unit trusts.
UTREFs and Trust REITs: How They Differ
REITs differ from UTREFs in that REITs are “closed-ended”. This means that the number of
shares remains constant (unless the REIT has a rights issue), and investors can only buy if there
are sellers. UTREFs are open-ended, meaning there is no limit to the number of new units that can
be created. Additional shares in a REIT can only be created with a rights issue. Typically this may
be done if the REIT wishes to acquire additional property, but does not want to use existing funds
for this purpose.
REIT fund managers are limited to investing in properties. If they have surplus cash, they are
allowed to invest in interest-bearing investments. Fund managers of UTREFs must invest at least
80% of the market value of their portfolios in REITs, other UTREFs and other property shares
(such as property development companies). They can invest up to 10% of their portfolios in related
businesses.
Because there are no guaranteed buyers for REITs, they can be sold for less than their true
value (NAV or net asset value). In other words, the purchase price of the REIT might be less than
the unit value of the underlying property holdings. This is also true of any other share traded on
the JSE. UTREFs, like other collective investment schemes, are always bought and redeemed at the
NAV price.
REITs may borrow up to 60%, subject to the provisions of the deed, for acquisitions or
refurbishing properties that they have bought for their portfolio. UTREFs may not take on debt.
This contrasts with private property syndicates or investment trusts that can borrow as much as
they like to fund acquisitions.

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Profile’s Unit Trusts & Collective Investments — Understanding Unit Trusts