Member Article

The long-awaited Royal Decree of 7 December 2010 on Real Estate Investment Trusts (REITs) (vastgoedbevaks/sicafi)
(the “Decree”) entered into force. The new legislation brings major changes. This article gives an overview of the most important legal changes, which can broadly be categorized into four topic areas. First, the Decree establishes a more
flexible procedure for raising capital. Second, it provides REITs with a variety of ways to structure their real estate portfolios, in particular by the introduction of the ’institutional REIT’. Third, the Decree brings major
changes to the financial requirements for REITs, in particular in relation to their debt ratios and profit distributions. Finally, the Decree introduces specific rules in various fields, ranging from a reduction in the amount of information to
be provided to the CBFA, more possibilities to grant security interests and a broader scope of the REIT’s promotor role. This window of opportunity has resulted in new REIT files; in the market at least four are said to be prepared.

1. Better access to capital markets

A.
More flexible capital increase by contribution in cash

Under the old rules, REITs could only
raise share capital through a time-consuming capital increase with preferential
subscription rights of the existing shareholders, and an offer period of minimum
15 days. Unlike other companies, REITs could not limit or cancel such preferential
subscription rights. Under the new rules, REITs can limit or cancel the
preferential subscription rights of shareholders. However, in such case, during
an offer period of minimum three business days, the existing shareholders can
still subscribe to the newly issued shares. The existing shareholders are given
an irrevocable priority allocation right (onherleidbaar
toewijzingsrecht/droit d’allocation irréductible), pro rata their respective shareholdings. This allocation right applies
to all newly issued shares; it cannot apply to only part of an issue. The
allocation right basically has the same economic effects as a preferential
subscription right, without the inconveniences (in particular the long
subscription period).

B. More flexible capital increase by contribution in kind

The Decree eases the restrictions on
the issue of shares as consideration for the acquisition of property by way of
a contribution in kind. Shares issued by a REIT in return for a contribution in
kind are subject to a minimum issue price. Under the old rules, the minimum
issue price was the average trading price of the REIT's shares during the 30
days prior to the capital increase. Under the new rules the minimum issue price
can be based on the average trading price or the REIT's net asset value (netto inventaris waarde/valeur nette
d’inventaire), whichever is lower. The net asset value cannot be older than
4 months prior to the date of the contribution agreement, or, at the choice of
the REIT, prior to the date of the issue.

However, under the new rules, not
only shares issued under a contribution in kind, but also shares issued
pursuant to a merger, split off and similar operations will be subject to this
minimum issue price requirement.

C.
Possibility to issue securities other than shares

The Decree explicitly specifies that
REITs can issue not only shares but also other types of securities, such as
convertible bonds and warrants. However, they can still not issue profit shares
(winstbewijzen/parts bénéficiaires)
and similar securities which do not represent any capital.  

D.
Possibility to offer an optional dividend
(keuzedividend/dividende optionnel)

The Decree explicitly permits REITs to
pay dividends to their shareholders, not only in cash, but also in shares. Each
of the shareholders can choose to receive a dividend in cash or shares. Cash is
king, but shareholders who opt for cash will see their shareholding diluted if
other shareholders opt for shares. Also, paying stock dividends enables REITs to
use the unpaid cash to strengthen their balance sheets, and, in turn, the
shareholder who opts for them may receive them at a discount.

2. New ways
to structure
the business

A. Institutional REITs

Probably the most remarkable innovation
the Decree brings is that an unlisted Belgian subsidiary of a Belgian REIT can
now benefit from the favourable tax treatment afforded to REITs. The subsidiary
does not have to merge with its parent any more to gain this benefit.

In order to qualify for favourable
tax treatment, the subsidiary must take the form of an ‘institutional REIT’.
The institutional REIT can have shareholders other than the REIT, but such shareholders
must be institutional or professional investors, such as pension funds or
credit institutions.

An institutional REIT can be created
as an ad hoc joint venture for a
specific project with a third party. In fact, the Report to the King mentions
that the institutional REIT’s purpose is just that. For instance, in PPP (Public
Private Partnership) transactions, it will enable public authorities to
participate in a non-listed REIT. Institutional REITs will be of particular interest
to large REITs, as they can now structure their different types of activities
in pools of separate subsidiaries, for instance by region or by sector
(offices, residential, pubs, senior housing, etc.). A similar type of REIT
already exists in other countries, particularly in France and The Netherlands. For
instance, some Belgian REITs have subsidiaries in France that profit from the French
REIT regime. It must be noted that under the new Belgian rules, it seems that only
Belgian companies controlled by a Belgian REIT can qualify for institutional
REIT status.   

Most of the provisions
applicable to public REITs are applicable, mutatis
mutandis, to institutional REITs. Like public REITs, institutional REITs
are controlled by, and must be registered with, the CBFA. However, as we will
also point out further on in this article, for certain specific topics, the rules
can be substantially different. For instance, unlike public REITs, but like
other Belgian companies, institutional REITs can completely cancel the
preferential subscription rights of their existing shareholders, without having
to grant them an irrevocable priority allocation right (see above).

If, at the level of the institutional REIT, a capital
increase in cash is made with a discount (‘disagio’)
of 10% or more, the board of directors of the public REIT must draft and
publish a report which justifies the discount.

B. Participations
in other companies

The Decree lays
down specific conditions for a public REIT to hold, either directly or
indirectly, shares in an institutional REIT or a real estate company. The
restrictions on the ownership of real estate through subsidiaries which are not
wholly owned can be seen as a trade-off for the introduction of the
institutional REIT. The rules are intended to avoid excessive use of joint
venture structures and to guarantee the interests of the shareholders of public
REITs. There are no specific restrictions in case the public REIT holds the
entire share capital of an institutional REIT or a real estate company.

First and foremost, the public REIT must
have (exclusive or joint) control over the subsidiary and its control cannot be
held jointly with another public REIT over which it has no control. The Decree provides
very specific and detailed caps and floors in relation to the value of the
shares (in terms of percentages of the consolidated net assets of the controlling
REIT). The controlling entity (or entities) must hold at least 50% of the share
capital of the subsidiary and the aggregate value of its (or their)
participation must not represent more than 30% (in case of exclusive control)
or 20% (in case of joint control) of the consolidated net assets of the
controlling REIT. Specific participation caps exist for when public authorities
are shareholders in the (exclusively or jointly) controlled entity. If the REIT
indirectly and jointly controls a subsidiary, only one exclusively controlled
entity can be put in between the REIT and such subsidiary. If there is joint
control, the REIT must be granted call and put options vis-à-vis the other
shareholder(s) that can be exercised if a conflict arises between the REIT and the
other shareholder(s) (‘deadlock’). If the put/call option is exercised, the sale/purchase
price of the shares is determined by experts appointed by the REIT and the relevant
shareholder(s) with whom the REIT is in conflict. Certain persons connected to
the public REIT, such as the promotor and the directors, cannot hold shares in
the REIT’s subsidiaries.  

If a public REIT controls one or more REITs, it cannot
at the same time have a Belgian law subsidiary that has the form of a real
estate company. Thus, the public REIT will have to choose the type of
subsidiaries it wants to have. If a public REIT controls one or more
institutional REITs and acquires control over a Belgian law real estate
company, it must comply with this rule within two years.

C. Investment diversification

As under the old Royal Decree, the property
risk of public REITs has to be spread: public REITs must diversify and cannot
invest more than 20% of their consolidated assets in a single building or site
which represents one single investment risk for the REIT. Specific derogations can
still be granted by the CBFA. The 20% rule is only applicable at the moment of
a specific relevant transaction. In other words, when the 20% limit is breached
solely due to a change in the portfolio’s fair value, a formal derogation from
the CBFA is not required. However, in such case, the board of directors must
follow up on the situation and decide whether or not the risk position of the
REIT must be reduced. The board cannot undertake any actions that would worsen
the risk position any further.

The Decree provides specific
requirements for the REITs if they invest in securities that do not qualify as
real estate, and in interest rate swaps and similar derivatives. Also, under
certain strict conditions, the REITs can enter into real estate leasing
agreements, as lessor or lessee.

The 20% rule is not applicable to
institutional REITs as such.

3. Less stringent financial requirements

A. Debt ratio

As under the old rules, a public REIT's
debt level must not exceed 65% of the value of its assets.  However, the Decree now says that this
percentage must be calculated, not only on a consolidated but also on a statutory
basis, but after deduction of the permitted interest rate swaps or other
derivatives used to hedge the REIT’s exposure to interest rate fluctuations. In
recent times, coupled with falling property prices, the falling value of interest
rate derivates made it difficult for some REITs to comply with the 65% debt
ratio requirement.

The Decree now says that the 65% limit
does not apply when it is exceeded solely due to a variation in the fair value
of the assets. However, if the breach of the 65% rule lasts for more than two
years, a general meeting of shareholders has to decide whether to dissolve the
REIT or to take other measures to remedy the breach, even if the breach is
solely due to a variation of the fair value of the assets.

The Decree further provides that, if
and when the consolidated debt level exceeds 50% of the consolidated assets, the
REIT must submit a plan to the CFBA outlining how it intends to prevent its
debt ratio from exceeding 65%, and the statutory auditor must prepare a report
in relation to the plan.

The 65% rule does not apply to institutional
REITs on a statutory basis.  Thus,
setting up an institutional REIT could be a technique to improve a public
REIT’s debt ratio.

B. Distribution of profits

The legal requirement for REITs to distribute
80% of their profits to their shareholders is also tempered by the Decree.
Given the state of property 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 under IFRS - the high 80% profit distribution level
made it extremely difficult for REITs to respect the maximum debt ratio of 65%
without increasing their share capital.

In principle, REITs are still
obliged to distribute 80% of their net profits to their shareholders. However, the
Decree now prohibits a public REIT from distributing profits if its debt ratio exceeds
the 65% limit or would exceed it because of the distribution. Undistributed
profits that would have been distributed if the 80% rule had been applied must
be allocated to the reserves and must be used to reduce the debt ratio below
the 65% limit.

The 80% rule also applies to
institutional REITs. However, unlike a public REIT, an institutional REIT can
distribute profits if, on a statutory basis, its debt ratio exceeds 65%. Nevertheless,
if an institutional REIT decides to distribute profits at a time when the debt
ratio of the public REIT exceeds the 65% limit or if it would exceed it because
of the distribution, the proceeds must be allocated by the public REIT to its reserves.
This rule (naturally) does not apply to institutional REITs whose entire
capital is directly or indirectly held by the same public REIT.

Referring to point 1.D above, we recall that REITs can
now pay dividends, not only in cash, but also in shares (‘optional dividend’).

C. Financial
statements

The Decree not only provides new rules in relation to the
general corporate legal framework of REITs, replacing the rules set forth in
the Royal Decree of 10 April 1995 on REITs. The Decree also replaces the Royal Decree
of 21 June 2006 in relation to the accounting, statutory annual accounts and
consolidated annual accounts of REITs. More specifically, it specifies new
rules in relation to the content, form and publication of the REITs financial
statements.

4. Other changes

The Decree introduces a variety of other
new rules, including:

·        
Real estate experts must now rotate,
and their remuneration cannot depend on the value of the property they
evaluate.

·        
The best efforts obligation of the promotors
to have at least 30% of the REIT’s share capital held by the public has become
a permanent, continuous obligation (previously, this was only required at the
REIT’s IPO).

·        
The board must include at least
three independent directors and the remuneration of the directors and managers is
regulated.

·        
Security interests can now, under
certain conditions, be granted for up to 50% of the fair value of the property (instead
of 40%).

·        
Depositories no longer have to be
appointed.

·        
The CBFA no longer has to be
informed on certain fees, commissions and costs.

·        
Specific new rules apply to REITs existing
under the form of a partnership limited by shares (commanditaire vennootschap op aandelen/société en commandite par action).

5. Entering into force

The Decree entered into force on 7 January 2011. Some
provisions are covered by grandfather clauses. For instance, the rule referred
to in point 2.B above which says that the public REIT will have to choose the
type of subsidiaries it wants to have (institutional REITs or real estate
companies) does not apply to real estate companies in which a public REIT has
held shares since at least 1 January 2009.

In any event, the existing REITs must amend their
articles of association to comply with the new rules by 7 July 2012.

6.
Conclusion

The Belgian
REIT sector has largely welcomed this long-awaited Decree. The new rules will
undoubtedly bring significant developments to property financing. Many of the
new rules provide much-needed flexibility for a number of REITs in current
markets. It should be noted however, that some specific rules introduce new
restrictions. Also, the flexibility introduced by the Decree does not always
imply transparency. Apparently, a new draft Royal Decree is being under
preparation to align Belgian REITs further with REITs of neighbouring countries
(French SIIC and Dutch BI).