Taiwan looks to build on success of Fubon No 1

With the enactment of the Real Estate Securitization Law (RESL) in 2003, real estate investment trusts (Reits) along with real estate asset trusts became legally possible in Taiwan. As elsewhere, a Taiwanese Reit is a pool of funds, generally raised through the issuance of beneficiary certificates to the public or to privately placed investors, for the purpose of making investments in real properties that could produce income to pay back the holders of the beneficiary certificates at their investment amount plus expected return.

The Real Estate Securitization Law was passed in response to the need to stimulate the real estate market in Taiwan and to provide another investment alternative to institutional investors as well as the general public, whose choices had been limited mostly to funds focusing on corporate bonds and shares. However, it seems that the market for Reits has yet to fully develop. By the end of February 2005, only one Reit (Fubon No 1) had been filed with and approved by Taiwan's Financial Supervisory Commission (FSC). During the same period of time, the FSC has approved a total of six real estate asset trusts. Nonetheless, the issue of Fubon No 1 was well received by investors; the offering was reportedly five times oversubscribed.

Forming a Reit

To form a Reit, a trustee must file an application with the FSC for approval before it can launch the offering. Along with the application, the required documents include, among others, an investment trust plan, trust agreement, offering circular or information memorandum, and description of the management and disposal of the real properties concerned. A reference letter will also be needed from the relevant authority (for example, the Ministry of Interior Affairs in the case of commercial buildings, and the Ministry of Transportation and Communication in the case of railways).

In addition, if a public offering is involved, an approval by the Securities and Futures Bureau will be required to ensure proper disclosure of information to investors. Decisions can be made in one to two months after the filing, but it is reported that the FSC aims to shorten the review period. The offering or placement must commence within three months of the approval, but that requirement can be extended for another three months upon request.

Trustees

A Reit will have a trustee who will be the registered owner of the underlying properties acquired by the funds. The trustee will also be responsible for receiving payments arising from the underlying properties and making distributions to certificate holders. The RESL permits real estate management institutions to carry out the management of the underlying properties, because those eligible to act as trustees in Taiwan are mostly banks, which lack the relevant experience and knowledge. Under the RESL, only enterprises that engage in the following four types of business are qualified to act as a management institution: real estate development, construction, construction management, and real estate leasing. In addition, the FSC has engaged Trust Association, a self regulatory organization, to draft criteria for a qualified real estate management institution.

Diversification

Taiwanese laws and regulations are silent about the diversification of properties under a Reit, and it is not clear if the FSC will require any degree of property diversification. In Fubon No 1, a total of three properties have been acquired, two of which are commercial buildings and the other being a servicing apartment. All generate rental incomes. However the FSC did indicate that a single-property Reit (that is, where all cash flow under the Reit is derived from one single property) is not encouraged.

Although it is not specified in the relevant regulations, the FSC's policy appears to be that the real properties a Reit is to acquire do not have to be specified in the investment trust plan when the filing for approval is submitted. Instead, the trustee can describe in the plan the types, geographic areas, and other features of the real properties the Reit is to invest in. Similarly, as long as the offering circular or information memorandum makes appropriate disclosures, the trustee is not required to decide on the properties to be invested in when raising funds.

However, a Reit can only acquire real properties that generate current cash flow, and is prohibited from acquiring those that are still under development. This issue was raised in the process of deliberating over the RESL and the bill did not originally contain such a limitation. At the last stage, the limitation was added to avoid the higher risks of creating a Reit that invests in a property under development. But little more than a year after the law was passed, there have been groups lobbying for its amendment to allow for investment in development projects.

Portfolio requirements

At least 75% of the net asset value of a Reit must be composed of cash (including bank deposits), government bonds, real properties ownership, real properties related rights, or securities issued under the RESL or the Financial Assets Securitization Law. In addition, the investment in securities by a Reit cannot exceed 40% of its total issued amount or NT$600 million ($19.17 million) whichever is lower. (In calculating the percentage or the amount, the investment in securities issued under the RESL or Financial Assets Securitization Law will not be counted.)

Any idle funds in a Reit can only be used in: (i) bank deposits; (ii) government bonds or financial debentures; (iii) treasury notes or negotiable certificate of deposits; (iv) accepted or guaranteed commercial paper or paper above certain ratings; and (v) any other investments as approved by the FSC.

Certain restrictions are also imposed on a Reit. They cannot:

provide guarantees, extend loans or provide collateral;
conduct securities margin transactions;
carry out any transactions between or among any Reits formed by the same trustee;
invest more than 10% of the net asset value of the Reit in short-term bills issued by a company;
deposit with a financial institution or invest in commercial paper or bonds, guaranteed or accepted by that financial institution more than 20% of the net asset value of the Reit and 10% of the net asset value of the institution;
allow the total amount invested in beneficiary certificates or asset-backed securities issued or delivered by other trustees or special purpose companies in accordance with the RESL or FASL to exceed 20% of the net asset value of the Reit; or
invest in real estate ownership and real estate related rights in accordance with the risk diversifying principle.

The RESL also gives the FSC the authority to set the scope of liquid assets in a Reit and the ratio of such assets to the entire portfolio. To date, the scope and ratio have not been set.

Lending limits

A Reit is allowed to borrow money and the underlying properties can be used as collateral for that purpose, provided that the borrowing is for the purpose of and, only to the extent necessary for, the management of the underlying properties and distribution of dividends, proceeds, or other profits to the certificate holders. The RESL also gives the FSC the authority to set a ceiling on how much a Reit can borrow. The FSC has not yet issued any ruling in regard to such a limit. In Fubon No 1, the investment plan set the limit at 35% of the asset value. As that limit was approved by the FSC, it might be used as a benchmark for other Reit transactions.

Distribution of profits

The RESL requires that profits (if any) of a Reit must be distributed each year, and does seem to require that all profits must be distributed. The investment trust agreement adopted by the FSC also seems to suggest that all profits out of a Reit must be distributed. The manner of profits distribution must be set down in the investment trust agreement and distributions must be made no later than six months after the end of the accounting year.

Open-ended funds

Reits in Taiwan are in principle closed-ended. An open-ended Reit can be issued only when approved by the FSC, but open-ended Reits face restrictions on, for example, the timing and volume of redemption to suit the less liquid nature of such funds. One-time offering is the norm. Having said that, raising additional funds is not expressly prohibited by the RESL, and there might be a chance that the restrictions on open-ended funds can be loosened if the FSC changes its policy.

Tax benefits

For tax purposes a Reit is a pass-through mechanism and no tax will be levied on the Reit itself. All profits arising from a Reit are deemed income of beneficiary certificate holders and will not be counted as business income of the trustee. In addition, underlying real properties and certificate holders enjoy the following tax benefits:

the annual depreciation expenses of the buildings in which a Reit invests may, by option, be calculated based on an extension of half of its original useful life as provided in the stipulated table for useful life of fixed assets (but after the option is exercised, it cannot be changed back during the life of the building); and
the profits distributed to the certificate holders will be withheld by the trustee, for the holders' income tax purposes, at the applicable withholding tax rates (which is now 6%) and such tax is calculated separately from the comprehensive income tax or business tax of the certificate holders.

Diversification of holders

It is required that a Reit must have at least 50 certificate holders for at least 335 days a year, unless the Reit is privately placed and all certificate holders are not individuals.

Also, the total amount of beneficiary certificates held by any five certificate holders of a Reit cannot exceed 50% of the total issued amount of the Reit unless all holders are independent professional investors.

The FSC may order Reits not to make any distribution if these requirements are not fulfiled.

If a Reit is to be listed on the Taiwan Stock Exchange, additional requirements are: (i) the total issued amount must be no less than NT$3 billion; and (ii) there must be at least 500 certificate holders who hold certificates in an amount of less than NT$1 million and the total amount of the certificates of such holders must be no less than NT$200 million.

Building on Fubon No 1

Taiwanese Reits are still at a developmental stage, and only transactions that are actually offered to the market can help expedite the process of its evolution. There are no major obstacles to hinder the growth of the market for Reits. There may be some constraints in relevant laws and regulations that unnecessarily tighten the flexibility of the products, but the regulators have been reasonably flexible and are generally quick to respond to market needs. The success of financial asset securitization, which became legally possible only recently, has proved that the Taiwanese market is accessible to new financial products and can embrace new investment alternatives in a short time, and it may not be long before Reits can also establish themselves in the Taiwanese market.

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