Introduction

Following a two-month industry consultation on the proposed amendments to the Code on Real Estate Investment Trusts (the “REIT Code”), the Securities and Futures Commission (the “SFC”) published the consultation conclusions on 27 November 2020 and revised the REIT Code in light of the responses with effect from 4 December 2020. Further guidance will be provided by way of Frequently Asked Questions issued by the SFC in due course. The reform allows more flexibility for Real Estate Investment Trusts in Hong Kong (“REITs”) to make investments, and helps maintain the overall competitiveness of the Hong Kong REITs regime in line with those in comparable overseas jurisdictions.

An overview of the Hong Kong REITs regime

REITs are collective investment schemes that primarily invest in income-generating properties such as shopping malls, offices, hotels and service apartments in Hong Kong and/or overseas. In Hong Kong, a REIT must be authorised by the SFC and listed on the Stock Exchange of Hong Kong (the “SEHK”). Investors can buy and sell units of the REITs in a similar manner as the shares of companies listed on the SEHK. Therefore, REITs are governed by the REIT Code and, where there are no specific requirements in the REIT Code, the relevant sections of the Rules Governing the Listing of Securities on the Stock Exchange (the “Listing Rules”) issued by the SEHK.

The regulatory requirements for REITs that are authorised by the SFC include, among other things:-

1.        having dedicated investments in real estate that generate recurrent rental income;

2.        distributing not less than 90% of net income after tax to unitholders as dividends;

3.        being subject to limitation on borrowings in relation to its total gross asset value (the “GAV”);

4.        being managed professionally by REIT managers who are licensed and approved by the SFC; and

5.        appointing an independent trustee which shall normally have minimum paid-up share capital and non-distributable capital reserves of HK$10 million or its equivalent in foreign currency.

Key changes made to the REIT Code

(i)  Allowing investments in Minority-owned Properties

The minority-owned properties refer to those jointly owned properties in which a REIT does not have more than 50% ownership and control (the “Minority-owned Properties”). Under the prior REITs regime, the investments in the Minority-owned Properties were not allowed and the REIT must have more than 50% ownership and control in each property at all times.

In view of the overwhelming support to remove such prohibition from the respondents to the consultation, and having regard to the practice in some other comparable overseas jurisdictions, the SFC decided to allow REITs to invest in the Minority-owned Properties and introduced the concept of Qualified Minority-owned Properties that satisfy both the overarching principles and specific conditions set out in the revised REIT Code (the “Qualified Minority-owned Properties”), which include, among other things:-

1.        the investment in such property is in line with the REIT’s investment strategy and objectives;

2.        prominent disclosures and warnings are provided on the risks and potential impact of the ownership structure on the REIT;

3.        the REIT must have freedom to dispose of such investment, subject to any customary pre-emptive rights and requirement on holding period;

4.        the REIT must have at least proportionate board representation; and

5.        the joint ownership agreement or other constitutive documents of the REIT must include certain terms as set out in the REIT Code, such as veto rights over key matters.

Under the reformed regime, the SFC’s approval for the Qualified Minority-owned Properties is required and serves as one of the fundamental safeguards to ensure that such properties satisfy the applicable principles and conditions. Further, the SFC requires that the value of an investment by a REIT into any single Minority-owned Properties (other than the Qualified Minority-owned Properties) must not exceed 10% of its GAV, and further requires that the aggregate value of investments by a REIT in the Minority-owned Properties (other than the Qualified Minority-owned Properties), property development projects and other ancillary investments must not exceed 25% of its GAV (the “25% Limit”).

(ii)  Relaxing the limit on investments in

Property Development Projects

Under the prior regime, a REIT may invest in properties that are unoccupied and not income-generating or in the course of substantial development, redevelopment or refurbishment (“Property Development Projects”), provided that the aggregate costs borne or to be borne by the REIT, together with the aggregate contract value of uncompleted units of properties do not exceed 10% of its GAV.

Under the reformed regime, the limit on investments in Property Development Projects is raised from 10% to 25% of the GAV. An existing REIT can be subject to the new relaxed 25% limit, after the unitholders of such REIT have consented to the increased limit by way of resolution at a general meeting, the increased limit has been permitted and effected pursuant to its constitutive document(s), and the REIT trustee has given no objection to the increased limit. Nonetheless, any investments in Property Development Projects shall be counted towards the 25% Limit as mentioned in section (i).

(iii)  Relaxing the limit on making Relevant Investments

Generally, REITs are required to focus on investments in real estate that generate recurrent rental income, as compared to the investments in securities listed on SEHK or other internationally recognised stock exchanges, unlisted debt securities, government and other public securities and local or overseas property funds (“Relevant Investments”). Under the prior regime, Relevant Investments made by a REIT were subject to a diversification limit, being that the Relevant Investments issued by any single group of companies must not exceed 5% of the GAV of such REIT. Under the reformed regime, the diversification limit applicable to Relevant Investments has been increased from 5% to 10%, and any Relevant Investments shall be counted towards the 25% Limit as mentioned in section (I).

(iv)  Relaxing the borrowing limit

A REIT is allowed to borrow monies for financing investments or operating expenses and to pledge its assets to secure such borrowings, but the aggregate borrowings (either directly or through the special purpose vehicles held by the REIT) are subject to a limit (the “borrowing limit”). Under the prior regime, the borrowing limit of a REIT was 45% of its GAV. Under the reformed regime, the borrowing limit has been increased from 45% to 50%. In the revised REIT Code, the SFC clarifies that, among other things, (i) only the borrowings of a REIT and its subsidiaries are aggregated for the purpose of calculating the borrowing limit; and (ii) refinancing existing borrowing for the purpose of repaying maturing borrowing would not generally be regarded as incurring further borrowing.

Other changes

In addition, the requirements for connected party transactions and notifiable transactions in the REIT Code are amended by the SFC to align the REIT Code with the Listing Rules, in line with the long-established policy and existing practices of regulating REITs in the same manner as listed companies. To ensure transparency in any transaction entered into by a REIT, the SFC has also added a separate disclosure requirement for all proposed acquisitions or disposals of real estate by a REIT, unless its size is less than 1% of its GAV.

Conclusion

The recent reform to the REITs regime is aimed at propelling the development of the REIT market in Hong Kong, which is considered essential in enhancing Hong Kong's status as a premier asset and wealth management centre. The REIT managers now have more flexibility in selecting acquisition targets and diversifying investment strategies under the enhanced REIT Code.