Updated: May 24
By Andrew Kemp
The Philippines’ economic recovery plans centre around infrastructure investment, which may drive renewed interest in real estate investment trusts (REITs)
The Philippines has thrown its entire weight behind combating the spread of the coronavirus (COVID-19), quarantining its citizens and embracing economic hibernation in a bid to limit the country’s death toll.
At the same time, however, the country has begun looking for an eventual endgame, when the world’s economies begin lifting their lockdowns and people return to work. Most governments’ timetables for such an endgame remain uncertain, with the Philippines extending its own enhanced community quarantines up to the end of April. A decision to extend the quarantine further will likely be influenced by results from the country’s mass testing programme, which began on April 14.
When Manila does begin to ease social distancing measures and looks to restart economic activity there will be a steep hill to climb before national growth levels return to normal. With this in mind, the government has said it intends for its ambitious “Build, Build, Build” infrastructure programme to drive the economy forward. At the same time, however, it has acknowledged that private investor appetite for such projects will be diminished owing to the pandemic’s economic fallout.
Consistent with the REIT Act, the latest amendment to the implementing rules and regulations issued by the SEC requires a minimum public offering (MPO) of one-third of a REIT’s total outstanding capital stock from 40% previously. At least 1,000 public shareholders must each own at least 50 shares of any class of shares.
Melyjane G. Bertillo-Ancheta, Partner, SyCipLaw
It is against this backdrop that the Philippines’ amended rules governing real estate investment trusts (REITs) – introduced in January 2020 – gain greater significance. The amended rules make REITs more attractive to investors than ever before, while allowing real estate companies access to a cheaper source of capital.
The government passed the Real Estate Investment Trust (REIT) Act in 2009 with the goal of increasing public participation in the real estate sector. Strict legal and regulatory requirements, however, have meant that not a single trust was set up in the years that followed.
To address this, the Philippine Department of Finance (DOF) amended the implementing rules and regulations of the REIT Act on January 30, 2020 to clarify several outstanding tax issues. The DOF’s move followed amendments made to the National Internal Revenue Code (Tax Code) – which took effect on January 1, 2018 – and the Securities and Exchange Commission’s (SEC) amendments to the REIT Act’s rules and regulations also in January 2020.
Melyjane G. Bertillo-Ancheta, a partner at leading Philippine law firm SyCip Salazar Hernandez and Gatmaitan (SyCipLaw), said: “Consistent with the REIT Act, the latest amendment to the implementing rules and regulations issued by the SEC requires a minimum public offering (MPO) of one-third of a REIT’s total outstanding capital stock from 40% previously. At least 1,000 public shareholders must each own at least 50 shares of any class of shares.”
The REIT needs to comply with these requirements, among others, to be entitled to various fiscal incentives such as the ability to deduct dividends from a REIT’s taxable income.
Another stumbling block was the fact that the transfer of real assets to the REIT was subject to value-added tax (VAT). The DOF’s amended guidelines addressed this by exempting transfers of real or personal property from VAT as long as that they are made in a “tax-free exchange” transfer.
Carina C. Laforteza, the head of SyCipLaw’s tax department, said: “In a ‘tax-free exchange’, the transferor transfers property to a corporation for shares of stock as a result of which the transferor, alone or together with others not exceeding four, acquires control of the corporation, and that ‘control’ means ownership of at least 51% of the total voting power of all shares entitled to vote.”
Additionally, REITs are no longer required to put their tax benefits and savings into escrow. However, the sponsor or promoter and principal shareholder of the REIT must submit their reinvestment plans to the Philippine Stock Exchange and the SEC for review to ensure gains are invested in the local market. The REIT must submit the reinvestment plan to the Bureau of Internal Revenue (BIR) as part of its registration requirements. The certification from the SEC that the REIT is compliant with its reinvestment plan must also be submitted to the Bureau of Internal Revenue (BIR) as an attachment to the REIT’s annual income tax returns and audited financial statements.
Philippine Finance Secretary Carlos Dominguez III said in January 2020 that the new rules were powerful financial instruments that would boost investment in property development and “democratise wealth by opening access to thousands of small investors wanting to be shareholders in secure and profitable real estate projects.”
Opportunities and challenges
“In a ‘tax-free exchange’, the transferor transfers property to a corporation for shares of stock as a result of which the transferor, alone or together with others not exceeding four, acquires control of the corporation, and that ‘control’ means ownership of at least 51% of the total voting power of all shares entitled to vote.”
Carina C. Laforteza, Head of Tax, SyCipLaw
By transferring their properties into REITs, property owners can access an alternative and cheaper source of capital. They also gain the opportunity to create fee-based businesses through external management contracts with REITs, which offer tax efficiencies, greater liquidity and portfolio diversification to investors.
The country’s real estate sector has benefited from annual economic expansion that has averaged slightly more than 6% per annum since 2010, with 2019’s growth of 5.9% marking an eight-year low in expansion rates.
The International Monetary Fund (IMF) projected in February that the country’s GDP would climb by 6.3% this year on the back of an acceleration in government spending and recent monetary policy easing. The body revised this down to just 0.6% in its World Economic Outlook (WEO) April 2020 report, given the economic impact of COVID-19.
This, however, still means the Southeast Asian nation is on track to avoid a recession and the IMF does expect the economy to bounce back in 2021. “Growth is projected to rebound to 7.6% in 2021 from a low 2020 base,” IMF resident representative to the Philippines Yongzheng Yang said on April 15.
Manila’s belief in the Build, Build, Build programme as an answer to COVID-19’s economic challenges may create newfound investment opportunities for real estate developers with the appetite for risk.
Finance Secretary Dominguez told CNN on April 13 that the government would focus on infrastructure developments as a way of driving the economy forward. “We have not downgraded our Build, Build, Build. That is going to be the fuel that will push, that will fuel our bounce back,” Dominguez said.
Presidential adviser for flagship programmes and projects Vivencio Dizon told the Inquirer on April 14 that Build, Build, Build could even be reconfigured to prioritise health infrastructure.
Dizon added that with interest rates at an all-time low and the Philippines’ relatively low debt-to-GDP ratio, Manila could comfortably access cheap financing. He said: “A huge part of this [COVID-19] response is going to be public infrastructure.”
International real estate company Colliers argued in January that the Philippines’ active pursuit of private sector investment in Build, Build, Build meant property firms should explore public-private partnership (PPP) projects covering hospitals, schools and toll roads.
There was a burgeoning appetite for REITs prior to the arrival of the COVID-19 pandemic, with leading Philippine land developer and real estate company Ayala Land filing an application for the country’s first REIT share sale.
Ayala Land’s subsidiary, AREIT, intended to offer as many as 478.64 million shares at a maximum price of PHP30.05 (US$0.594) per share, with an option to sell another 23.93 million overallotment shares. The sale had the potential to raise up to PHP14.4 billion (US$284.5 million). Ayala Land said it would raise as much as PHP1.36 billion (US$26.9 million) in net proceeds to fund future property investments.
With the government tailoring its economic recovery strategy around a multi-billion-dollar infrastructure programme, the real estate market appears to be a significant beneficiary.
It is unclear what the immediate future holds for the Philippine economy, given the unprecedented social and economic measures that government has adopted. Private investors will be risk averse following the economic fallout from the pandemic, would could make REITs a more attractive option in a period of economic uncertainty. Real estate companies also stand to benefit, both from increase access to cheaper capital and greater government desire to see private participation in the rebuilding of the nation’s economic wellbeing.
This article was written by Andrew Kemp for Conventus Law in association with SyCipLaw. For further information on the REIT market in Philippines, please contact:
Carina C. Laforteza (firstname.lastname@example.org)
Partner; Head of Tax Department
Melyjane G. Bertillo-Ancheta (email@example.com)