On December 4, 2020, the Hong Kong Securities and Futures Commission (SFC) gazetted changes to the Code on Real Estate Investment Trusts (REIT Code) following a two-month industry consultation on the enhancements. The amendments to the REIT Code (Reforms) will provide Hong Kong real estate investment trusts with more flexibility in making investments which include
- allowing REITs to make investments in minority-owned properties (subject to conditions)
- allowing REITs to make investments in property development projects in excess of the existing limit of 10% of gross asset value (GAV) (subject to unitholders’ approval and other conditions)
- increasing the borrowing limit for REITs from 45% to 50% of their GAV
The Reforms include other changes that broadly align the requirements applicable when REITs engage in connected party transactions and notifiable transactions with the requirements for listed companies, in line with existing policy and practices. A transitional period of six months will be allowed for existing REITs to comply with these revised requirements.
The Reforms are widely welcomed by the industry and represent the latest in a series of recent changes introduced by the Hong Kong government to bolster Hong Kong’s position as a premier asset and wealth management hub.
Whom does this affect?
The Reforms are relevant to existing REITs and their management companies (REIT Managers) as well as real estate asset owners and managers who may be interested in establishing a REIT in Hong Kong.
Overview of the key enhancements
The table below summarizes the key enhancements to the REIT Code implemented in the Reforms. The Reforms include various other changes aimed at aligning requirements and codifying existing practices, including changes to broadly align the requirements for connected party transactions and notifiable transactions with the requirements under the Rules Governing the Listing of Securities on the Stock Exchange of Hong Kong.
| Existing Requirements | Key Enhancements | Comment | |
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Minority-owned properties |
A REIT is allowed to own less than majority ownership and control in a property (Minority-Owned Properties), provided that investments in such Minority-Owned Properties do not in aggregate exceed 10% of the REIT’s GAV (10% Cap). |
The Reforms differentiate between investments in Qualified Minority-Owned Properties and Non-Qualified Minority-Owned Properties. A Qualified Minority-Owned Property is Minority-Owned Property that fulfills the conditions specified in Chapter 7.7C of the REIT Code and is approved by the SFC. The conditions include overarching principles (such as the investment being in line with the REIT’s investment strategy and objectives) and specific requirements (such as the REIT must have at least proportionate board representation and certain requirements that the joint ownership agreement or other constitutive documents must satisfy). A REIT’s aggregate investment in Non-Qualified Minority-Owned Properties, property development projects, and other ancillary investments must not exceed 25% of the REIT’s GAV (25% Cap). Investments in Qualified Minority-Owned Properties are not counted toward the 25% Cap. The value of an investment into any single Non-Qualified Minority-Owned Property must not exceed the 10% Cap. |
This Reform significantly increases the investment scope for REITs by enhancing their flexibility to invest in Minority-Owned Properties. The increased flexibility will enable REITs to more easily diversify and expand the scope of their real-estate-related investments for the benefit of unitholders. This Reform brings the Hong Kong REITs regime generally in line with other major REIT jurisdictions. |
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Property Development Projects |
A REIT must not engage in property development and related activities unless the aggregate property development costs (being the total project costs borne, and to be borne, by the REIT) together with the contract value of uncompleted units of real estate do not exceed the 10% Cap at any time. For this purpose, investment in property development and related activities does not include refurbishment, retrofitting, and renovations. The combined value of property development projects, Relevant Investments (see below), and other non-real estate assets of the REIT must not exceed the 25% Cap. |
Engagement by REITs in project development and related activities continues to be subject to the 10% Cap.
However, this cap may be increased to 25% of GAV for a REIT seeking SFC authorization if (i) it is permitted by the constitutive documents of the REIT and (ii) there is clear disclosure in the offering document. This cap may also be increased to 25% of GAV for existing REITs, provided that (i) unitholders have consented to such increase by way of resolution at a general meeting, (ii) the increase is permitted and effected in accordance with the REIT’s constitutive document, and (iii) a no objection from the REIT trustee has been obtained. The combined value of Non-Qualified Minority-Owned Properties, property development projects, Relevant Investments, and other ancillary investments must not exceed the 25% Cap. |
This Reform provides greater scope for REITs to invest in property development projects, which gives REIT Managers more flexibility in selecting acquisition targets and diversifying investment strategies. |
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Relevant Investments |
A REIT may invest in securities listed on internationally recognized stock exchanges, unlisted debt securities, government and other public securities, and local or overseas property funds (together, Relevant Investments). The aggregate value of Relevant Investments issued by a single group of companies must not exceed 5% of the REIT’s GAV, and the Relevant Investments must be sufficiently liquid. The combined value of Relevant Investments, property development projects, and other non-real estate assets of the REIT must not exceed the 25% Cap. |
The aggregate value of a REIT’s Relevant Investments issued by a single group of companies must not exceed the 10% Cap. The combined value of Relevant Investments, Non-Qualified Minority-Owned Properties, property development projects, and other ancillary investments must not exceed the 25% Cap.
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This change aligns the diversification limit for Relevant Investments with the limit for any single Non-Qualified Minority-Owned property and promotes diversification. |
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Borrowing Limit |
A REIT may borrow (either directly or through its SPVs) for financing investment or operating purposes, but aggregate borrowings must not at any time exceed 45% of its GAV. The REIT may pledge its assets to secure such borrowings. A REIT must not lend, assume, guarantee, endorse, or otherwise become directly or contingently liable for or in connection with any obligation or indebtedness of any person, nor can its assets be used to secure the indebtedness of any person, nor can its assets be used to secure any obligation, liability, or indebtedness without prior written consent of the REIT trustee. |
A REIT may borrow (either directly or through its SPVs) for financing investment or operating purposes, but aggregate borrowings must not at any time exceed 50% of its GAV. Other requirements and restrictions in relation to the lending and pledging of REIT assets continue to apply. The SFC has also clarified that refinancing existing borrowing for the purpose of repaying maturing borrowing generally will not be regarded as incurring further borrowing. |
This Reform brings the Hong Kong REITs regime generally in line with other major REIT jurisdictions. |
What happens next?
The Reforms became effective upon gazettal on December 4, 2020. The revised REIT Code, together with updated frequently asked questions reflecting the Reforms, are now available on the SFC website.
The Reforms are expected to significantly enhance the utility and competitiveness of Hong Kong’s REIT regime. Coupled with other initiatives aimed at facilitating market operation and broadening the investor base, the Reforms are expected to bolster the attractiveness and competitiveness of Hong Kong’s REIT regime relative to comparable structures available in other developed fund centers and aid in the development of a vibrant REIT market in Hong Kong.
If you would like to hear more about these developments, explore how you can capitalize on these changes, or receive a copy of our summary of the key requirements applicable to REITs and REIT Managers, please contact us.
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