Tenanted pubcos could benefit most from proposed changes in regulations around tax-efficient real estate investment trusts (REITS), according to a leading city analyst.
The Government is to begin an informal consultation into REITs for inclusion in the 2012 Finance Bill, seeking views on abolishing the 2% conversion charge for companies to join, extending the time limit for complying with the dividend distribution requirement, and giving REITs the option of holding cash.
Pub companies including managed operator Mitchells & Butlers and tenanted pubco Enterprise Inns have examined the idea of converting to a REIT in the past.
Douglas Jack at Numis said: “It is questionable whether pubs will (or would want to) qualify [for REIT status], but the change in Government approach could reignite the debate.
“When REITs were last in vogue, in H2 2006, pub share prices soared even though it was unclear whether their rental income would quality. The current proposals under consultation give the impression that the Government is trying to be more inclusive.
“Should companies wish to convert to REIT status? In 2006, our view was that the disadvantages of potentially creating an over-leveraged operating company (opco), which cannot guarantee sales rising as quickly as rent, either made REITs a non-starter or outweighed the potential benefits of tax-reduction.
“Necessary conditions for considering REITs, in our opinion, are: a) pub rent qualifying; b) net tax payments being reduced; c) a willingness to de-merge, in the case of managed pub companies; d) over-leverage being avoided; and e) managed pub OpCos being sufficiently well-positioned.
“For managed pubs, investors’ aversion to higher leverage conflicts the REITs benefit resulting from higher opco leverage through adding an inter-company rental tax shield. Leverage could be reduced by transferring debt to the propco, but this would reduce the interest tax shield (bringing a zero sum gain).
“Tenanted pubcos would benefit if rental income effectively became tax-free, with limited restructuring being required. It is questionable whether HMRC can afford to give away such a windfall for little in return.
"Overall, it is early days and there are a lot of ‘ifs’ involved, but the debate could lead to pick up in sector interest, with tenanted pub companies potentially benefiting most.”
