Real estate in 2023: A trustee’s perspective on the current challenges and opportunities
Ahead of MIPIM, the world’s leading real estate market event, we spoke to Nina Johnston, Equiom’s Isle of Man Location Head to find out why real estate continues to be a key asset in HNW’s investment strategies.
Real estate features as an asset class in a large proportion of portfolios for HNW, why is that?
I have to say, I’m quite an old school trustee and was brought up on the inherent value of bricks and mortar – for the majority of people, it will be the most valuable asset they will ever hold and in much the same way, it forms the basis of wealth for a number of our HNW clients. Furthermore, it has a proven track record of capital appreciation over a prolonged period and can generate excellent cashflow to reinvest either in additional property or other asset classes. I have clients who created trusts for succession planning purposes many years ago, starting with one commercial property with a modest valuation which have grown to more than 20 separate assets with overall portfolio valuations in excess of £100m. It takes careful management and sometimes a hard nerve, but the returns over the long term have been incredible.
With interest rates on the rise, how are investors in property reacting? Has this created challenges or opportunities?
Without a doubt the current inflationary pressure and increasing interest rates are creating challenges. An additional 3% on a £10million facility on renewal will take £300k straight off the bottom line, then throw in tenant default on rents – it certainly adds significant cashflow pressure and puts banking covenants at risk. In addition, the rising interest rate environment has increased investment yields which conversely introduces downward pressure on valuations, another lending default risk. This is where the governance aspect of our role comes in with trustees and directors meeting to review performance and take proactive steps at an early stage to manage risk of default. With each challenge however there is also opportunity, for those clients in a fortunate position to be cash rich, we can assist with structured finance solutions through our membership of TISE (The International Stock Exchange) which allows interest to flow in a tax efficient manner.
What is the most common structure type that you see?
There really isn’t a common type, every UBO and asset will have their own unique circumstances and business objectives, so the ownership structures are bespoke. We look after single SPV entities with single shareholders, those owned by a trust or those with multiple shareholders and subject to collective investment scheme rules. Elsewhere, we could be looking after multi-generational/multi-jurisdictional family trusts with multiple underlying vehicles owning real estate in different jurisdictions, but all falling under the umbrella of one ultimate trust.
We sit on the boards of shopping centres, we own student accommodation, we look after trophy London properties or a smaller portfolio of corner shops and commercials units – in each case we work with trusted advisors to implement the most appropriate structuring to achieve the desired outcomes.
What are the biggest myths around property structures and their benefits at the moment?
There is plenty of information out there that suggests offshore ownership of real estate is less attractive than it used to be. We just need to look at IHT (inheritance tax), CGT (capital gains tax) and ATED (annual tax on enveloped dwellings) on some residential property, plus the loss of the CGT advantage for commercial real estate and the upcoming increase in corporation tax rates to 25%. A lot of these factors would suggest there is no benefit to property ‘structures’ anymore – however I would disagree. The tax advantages are being eroded, but that doesn’t mean these structures are without benefit.
The primary goals for the majority of our clients are succession planning and asset protection – our clients have worked hard to build their wealth and they want to ensure that it can be passed to the next generation - intact with the greatest value possible. We have seen some onshoring of assets in recent years, but ultimate ownership remains within a holding entity (be that a trust or company) forming part of much wider asset portfolios.
The trustees and directors still receive the benefit of dividends/cashflow surplus through upstreaming without the same level of costs being incurred to manage those particular assets offshore. That said, there are some clients who continue to hold their assets, as they always have, within their carefully advised and well governed structure due to the comfort that they take from the assets being professionally managed. To some, the day-to-day operational aspects of maintaining complex real estate portfolios is a task they wish to be dealt with on their behalf.
It is also wrong to assume that all tax benefits have been eradicated. There is a common assumption that anyone holding residential property within an offshore structure will be subject to taxes that they otherwise wouldn’t be subject to. But typically, offshore jurisdictions are tax neutral, and significant inheritance tax benefits remain for non UK domiciled individuals. It is always best to explore the facts in full before jumping to incorrect assumptions.
What is keeping you busy from a real estate perspective now?
We have recently created a new Property Unit Trust which is authorised under the Isle of Man Collective Investment Scheme Rules. The trust will have in the region of 120 unit holders and will invest £120m into UK commercial property, such as logistics and data centres. We have also got a high profile central London super prime office and retail redevelopment underway which covers almost every aspect of real estate law that you can imagine. This is a great example of our breadth of services, as we have held this asset within our portfolio for over 20 years and have been on quite the journey:
- managing the asset on behalf of a consortium of investors
- overseeing the corporate sale of the property to an Asian property giant
- supported two rounds of refinancing
- seeing the building partially demolished and redeveloped to the highest possible ESG (environmental, social, and governance) standards, which are to be independently certified under the BREEAM (Building Research Establishment Environmental Assessment Method) and WELL ratings systems
Elsewhere, we are busy renegotiating finance terms and working with some exciting prospective tenants in some of our larger commercial units. We are experiencing challenging valuations on some retail units within the portfolio, which is creating pressure with lenders, but we are working hard to manage the moving parts.
Are sanctions impacting investor behaviours and if so, how?
The impact of sanctions is being felt far and wide and I expect real estate agents are seeing a significant drop in enquiries from certain parts of the world for obvious reasons. For us, as the legal owners when a structure is put in place, we fortunately have no exposure to any real estate assets that we cannot manage as a result of sanctions, which is a blessing. I imagine there are a number of trust and corporate service providers, like ourselves, who are in a position where they have assets of considerable value and may no longer have access to funding to ensure that their fiduciary obligations are met (i.e. making sure the assets are adequately insured at the very least), as funding mechanisms are progressively being cut off due to sanctions.
The biggest impact for us has not been the sanctions, but the legislation which has been passed regarding the Register of Overseas Entities under the Economic Crime Bill. This is a way to establish who sits behind the offshore companies that own real estate in the UK. I am delighted that we were able to register all entities that we provide management services prior to the deadline of 31 January. We are already hearing noises that a significant number of entities have yet to register and there has been a lot of confusion on the definitions of controllers, particularly in the cases of trust ownership, so I’m sure we will hear more on this subject as the year progresses
If you have any questions on any of the above topics or would like to discuss your circumstances, please contact Nina Johnston.
